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A Wait-and-See Legacy Planning Approach: Maintain Flexibility While Getting a Foot in the Door

One of the key challenges to legacy planning for clients and their advisors is designing and implementing long term strategies based on short-term laws. As it seems to be the case every election cycle or so, we are now faced with more uncertainty on the future of tax law - especially as it pertains to the estate tax exclusion amount (and the potential change to step-up in basis rules).

The Tax Cuts and Jobs Act of 2017 (TCJA) increased the federal estate gift and generation-skipping transfer (GST) tax exemptions from $5,000,000 (indexed for inflation) per person to $10,000,000 per person (indexed for inflation) beginning January 1, 2018. In order to comply with certain budgetary constraints, the TCJA contains a “sunset”, or expiration date, of December 31, 2025 at which time the previously listed exemptions are set to expire and revert back to the previous $5,000,000 (indexed for inflation) levels.

While it may appear that there’s a legislative pathway of understanding how these exemptions are set to change, there are several examples over the last 20 years of how this might not happen. The Economic Growth and Tax Relief Reconciliation Act of 2001 gradually raised the exemption amount from $675,000 to $3.5 million in 2009. Without long term legislative action in place, the estate tax was temporarily eliminated in 2010. In a somewhat unexpected manner, the exemption didn’t revert to the $675,000 level in December of 2010 but instead was raised to $5,000,000. In early 2013, when that law was set to expire, Congress permanently set the exemption at $5,250,000 and enacted law changes to raise it annually with inflation.

With the outcome of the Georgia Senate run-off now complete, and Democrats seemingly in control over both houses of Congress and the Executive Branch, the chances for significant tax legislation increase significantly. Coupled with the continued economic pressure due to and eventual economic stimulus to combat the pandemic, the Federal government will at some point need to raise revenue to offset these expenditures. President-Elect Joe Biden has several proposals that contain language to reduce the exemption levels down to $3,500,000 per individual. **

Based on the current sunset language of the TCJA, the change in Presidential party representation, and the projected fiscal year federal government to rise to $3.7 trillion in 2020, there is reason to believe a reduction in exemption levels will occur at some point in the next few years.

With all this uncertainty flexibility is a key aspect of planning. For clients below the current exemption levels, they may not know if they have or will have an estate tax liability or how big it will be. Further, gifting significant assets either in a lump sum or creating an annual gifting plan above their annual exclusion limits may present cash flow issues and/or, most likely, a hesitance to lose control over assets during life.

A potential solution to this quandary is a “Wait-and-See” approach using a permanent survivorship insurance policy funded by a single premium designed to carry the policy for a limited time to lock in current insurability and pricing. At some point in the future, depending upon changes to tax law and/or the client net worth and/or family situation, the insureds will determine whether to pay future premiums to increase the coverage, lapse or surrender the policy, or reduce and maintain some form of coverage.

This asset can be held in the estate and, if it is to be maintained, transferred into an Irrevocable Life Insurance Trust (ILIT) at a later date. By owning the policy outright, the insureds have access to the cash value during life should they need it, further increasing the flexible nature of this design. If and when there is a change to exemption levels, the policy can be gifted or sold to an ILIT moving the death benefit (and cash value) out of the estate for tax planning reasons.

Depending upon the age and insurability of the individuals, it may be possible to combine a cash accumulation policy (such as Variable Universal Life, Indexed Universal Life or Current Assumption Universal Life) with a limited or lifetime contractual death benefit guarantee. The secondary guarantee may provide death benefit protection for a set amount of time based on the planned premium schedule to guarantee the policy will remain inforce independent of external economic factors or changes to underlying insurance costs. Continued low interest rates have negatively impacted the pricing of these types of guarantees and we anticipate that the downward pressure will continue increasing the cost in the future.

This Wait-and-See design can be particularly attractive to clients in their 40’s and 50’s due to the changes for IRAs and Defined Contribution Plans after the passing of the SECURE Act. The benefits of the SECURE Act were allowing contributions to traditional IRAs after Age 70 ½ and pushing back the Required Beginning Date (RBD) of Required Minimum Distribution (RMDs) from 70 ½ to 72. To offset the future cost of delaying income tax revenue through these changes, the SECURE Act essentially eliminated the Stretch IRA as a legacy planning tool. Unless one of the limited exemptions apply, benefits generally must be fully distributed from Inherited IRAs to Designated Beneficiaries within to 10 years of the account owner’s death. This change may dramatically impact the income tax burden on receiving beneficiaries of substantial inherited IRAs.

Combining the Wait-and-See concept with IRA tax-planning, clients can “seed” the policy with an initial premium from taxable savings or current cash flow and design the policy to remain inforce until qualified money can be accessed without penalty. This technique creates a secondary benefit of recharacterizing dollars that would be taxable to beneficiaries into a tax-free death benefit.

Beyond the Internal Rate of Return (IRR) of life insurance as an asset class, this valuable tool provides other key benefits to an overall plan, including liquidity almost immediately upon death, income tax-free benefits, the ability to add contractual death benefit guarantees, a hedge against premature death and an asset that does not require valuation or that is subject to volatility.

*Registered representative of and securities and investment advisory services offered through Hornor, Townsend & Kent, LLC (HTK). Registered Investment Adviser. Member FINRA/SIPC; Eight Tower Bridge, 161 Washington Street, Suite 700, Conshohocken, PA 19428) 610-771-1019)

HTK does not offer tax or legal advice. Consult your tax or legal professional.


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