Is the Estate Tax Dead?
The question for planners is, how long will the federal exemption remain so high? Unfortunately, no one knows. We can, however, apply our common wisdom, realizing that as Mark Twain said, “history doesn’t repeat itself but it does rhyme.”
The estate tax is known to have existed in 700 B.C. in Egypt and as well as in ancient Rome. In this country, various forms of the estate tax were imposed throughout the 1700s and 1800s. It was again enacted in 1916 during the “Progressive Era,” which arose in a populist response to years of great wealth being accumulated in the hands of a few, the fear of a corresponding abuse of power, along with long inaction by Congress. Does this situation sound familiar?
The most recent changes to the estate tax were made permanent with the passage of the American Taxpayer Relief Act of 2012 (ATRA). Most people who work in tax policy area consider the term “permanent” as another way of saying “one election cycle away.” The estate tax has been changed approximately 40 times in the 100 years since its enactment, and it is a safe bet that it will be changed again, even if that may be in a decade or two.
One thing that concerns me is that I see people making decisions about their estate plans as if the estate tax will never again be an issue. In particular, they may have a permanent life insurance policy they bought to help pay estate taxes, and now they are letting these policies lapse “because there isn’t any estate tax anymore.”
It is true that there’s no estate tax today, except for the very wealthy, but there might very well be one in the future. It might come back as a concern when you’re uninsurable, so, to me, it makes sense to keep an existing life insurance policy in force as a hedge against future changes. Permanent life insurance is never a bad thing. It provides your family with protection, and, through its accumulated cash value, it offers other possibilities that you can take advantage of over the course of your life.
Here in Advanced Sales, we spend a good deal of our time helping agents and their clients repurpose their life insurance as their lives change. For example, a policy purchased for survivor needs might next be used for supplemental college funding, and then supplemental retirement. A key person policy might also support a buyout arrangement or a deferred compensation plan.
One of the life insurance mistakes we often encounter is that insureds lapse or surrender their policies during the best of times, when life seems to be under control and predictable. And then, life happens, and they find they need insurance again, but sometimes they are now uninsurable.
I would apply the same lesson to the estate tax. We are currently in the best of times on the estate tax, but public policy happens and things change. The timeframe for the change may be a decade or two, but life insurance and estate planning are also things that are intended to work over a timeframe of a decade, or more. Nobody knows the exact timing of a change to the estate tax, but the chances are good that it’s likely to happen, so people should still be taking steps now to position themselves. It’s just part of a diversified strategy.
Certainly, if someone has an existing permanent life insurance policy purchased as part of an estate plan to help pay estate taxes, do not surrender it. Instead, use it now as part of legacy planning. Clients may choose to spend down their other assets knowing that the life insurance can be part of the legacy they leave their beneficiaries. Or they may decide to name or add a charitable beneficiary. Or they may use the accumulated cash value for life’s possibilities. Then, if the estate tax comes back, they will have insurance in place to help pay taxes once again.
Life insurance policies contain exclusions, limitations, reductions of benefits and terms for keeping them in force. Accessing cash values may result in surrender fees and charges, may require additional premium payments to maintain coverage, and will reduce the death benefit and policy values. Partial withdrawals during the first 15 policy years are subject to additional rules and may be taxable. Excess policy loans can result in termination of a policy. A policy that lapses or is surrendered can potentially result in tax consequences. Always consult a qualified tax advisor regarding your personal tax situation and a qualified legal professional for your personal estate planning situation.
 According to Darien B. Jacobson, Brian G. Raub, and Barry W. Johnson, all with the Internal Revenue Service and writing in “The Estate Tax: Ninety Years and Counting” which can be found at http://www.irs.gov/pub/irs-soi/ninetyestate.pdf.