On Dec. 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 — a move that had enormous implications for our industry. More specifically, it transformed the way many agents and clients look at life insurance. How has it impacted sales? What effect will it have on many of your clients’ portfolios? Here, I examine both of these timely questions.
Relief for taxpayers
One key feature of the 2010 Tax Relief Act is that it offers taxpayers relief from all federal estate, gift and generation-skipping transfer (GST) tax liabilities in three key areas.
First, it sets the exemption amount for all three of these tax liabilities at $5 million per person (beginning in 2012, this $5 million exemption amount will be indexed for inflation). The Act also unifies the federal estate tax and gift tax systems with a common $5 million per person exemption. Thus, married couples together receive a $10 million exemption from these tax liabilities. Considering that, in 2009, the exemption from federal estate tax and GST tax
liabilities was $3.5 million per person, and just $1 million per person from federal gift tax liability, this is a very large break for a very large number of taxpayers.
Second, the Tax Relief Act of 2010 applies a tax rate of 35 percent for all federal estate tax, gift tax and GST tax purposes, a significant drop from 2009’s tax rate of 45 percent. Because of this, even if a taxpayer exceeds the $5 million exemption amount, he or she will be subject to a lower tax rate and liability.
Third, the Act introduces a new concept to estate planning: portability. Under prior law, the unused exemption amount of a deceased spouse could not be utilized by the surviving spouse, which meant that the survivor faced a greater potential for federal estate tax liability on death. Now, the unused exemption of a deceased spouse is “portable,” meaning that it can be used by the surviving spouse. Not only does this reduce the potential for federal estate tax liability on the death of the second partner, it also simplifies the documentation process. Taxpayers with smaller estates who want to transfer all assets to their spouses no longer need to use complicated “multiple A/B testamentary trusts” to structure their estate plans. Instead, they can use simpler estate planning documents, with a single testamentary trust or, in some cases, none at all.
What does all this mean for life insurance agents? While, for many, the 2010 Tax Relief Act defeats a classic life insurance selling point — to fund potential tax liabilities — this new regulation doesn’t necessarily mean sales will drop. In fact, two other features of the Act suggest quite the opposite impact. Let’s take a look at how these might play out.
Feature No. 1: The Tax Relief Act of 2010 is effective for only two years.
One critical limitation on the applicability of the 2010 Tax Relief Act is that it is only effective for two years. Absent other governmental action, in 2013, the exemption amount will be reduced to $1 million per person for estate and gift tax purposes, and to the same amount for GST tax purposes, subject to indexing for inflation. Additionally, the tax rate for all federal estate, gift and GST tax purposes will increase to 55 percent, and there will be no more portability.
In light of this, we should encourage our clients to proceed cautiously before reducing their life insurance coverage over these next 14 months. There are two reasons for this: First, clients may need to maintain life insurance to pay for future tax liabilities; second, if they cancel a life insurance policy today, they may find that they are uninsurable or cannot afford new life insurance if they need coverage in 2013.
Feature No. 2: Gifting opportunities increase under the Tax Relief Act of 2010.
Even better for our industry, it may be beneficial for some clients to buy additional life insurance. Here’s why: The payment of premiums on a life insurance policy can result in a potentially taxable gift, especially when owned by an irrevocable life insurance trust. By increasing the federal gift tax exemption from $1 million to $5 million, clients can pay higher premiums and thereby purchase increased life insurance, tax-free. In addition, the Tax Relief Act of 2010 maintains the current annual gift tax exclusion of $13,000 per donee, which can also still be used to avoid federal gift tax liability on premium payments. By paying premiums with gifts, clients may be able to avoid more complicated funding mechanisms, such as split-dollar arrangements. «
Gary J. Stern is a partner at Chicago-based law firm Stahl Cowen Crowley Addis LLC. He can be reached at firstname.lastname@example.org.