Should clients dump their life insurance policies because of the estate tax repeal?
By Roccy Defrancesco
The Wealth Preservation Institute
Question: Does anyone really like paying their annual life insurance premium?
Answer: No, most do not.
Question: Why do many affluent people buy life insurance?
Answer: To pass wealth to their heirs or to pay for estate taxes that will be due so the entire value of the estate will pass to their heirs.
The estate tax exemption is temporarily $5 million per person
As you should now know, if Congress did not act prior to the end of 2010, the per person estate tax exemption would have reverted back to $1 million per person. Because Congress acted, we now have a temporary — two-year — period where the estate tax exemption is $5 million per person.
Estates of less than $5 million to $10 million
What if you have clients who are married, have a life policy in an irrevocable life insurance trust (ILIT) and an estate of less than $10 million? What should you tell them to do with the life insurance policy? Should you tell them to stop paying premiums on the policy because of the new estate tax law?
Not if you're smart.
Let me go over an example that I foresee being very common — a disaster waiting to happen.
Assume the example clients are a married couple, both 55 years old. They have assets that for estate tax purposes are worth $5 million. With growth and expenditures in retirement, their assets are projected to be $10 million by the time they turn 85 — their assumed age of death.
The couple was counseled a few years ago to buy a $2.5 million life insurance policy inside an ILIT to help pay for the estate taxes that will be due upon their death. The assumption by the adviser helping these clients when the policy was purchased is that the per head estate tax exemption at their death would be $2.5 million ($5 million per couple) with the top estate tax rate of 50 percent.
If the policy wasn’t purchased, the couple’s estate would owe estate taxes of 50 percent on $5 million of their estate, assuming the per head estate tax exemption is $2.5 million and used properly at their death.
The couple pays $20,000 a year for the premium on the $2.5 million policy in the ILIT. They do not like paying the premium, but see it as a necessary evil to make sure all of their wealth passes to their heirs upon death.
When the couple heard Congress passed a $5 million per head estate tax exemption at the end of 2010, the first question that came to their minds was whether they could stop paying the premium for their policy in the ILIT.
Their first call was to the life insurance agent who sold them the policy.
Is it a good idea for this couple to give up their policy? No, it’s a terrible idea.
Any planner who tells this couple to stop paying the premium, to give up the policy, or even to sell it in the life settlement market for cash should be prepared for a future lawsuit from the clients or their heirs.
The $5 million per head exemption is only for two years. We have no idea what will happen at the end of 2012 when President Obama and much of Congress runs for re-election.
- The law could still revert back to $1 million per person starting in 2013.
- The law could be extended out one to two more years.
- The law could be amended to pass what we all thought would happen — a $3.5 million per person estate tax exemption.
Advisers should be discussing the tenuous nature of the estate tax repeal and should tell clients to bite the bullet and protect their families.
I recommend that clients who already have assets in excess of $2 million keep all of their estate planning life insurance policies in place until a permanent estate tax repeal is passed — and then it’s still not permanent, because Congress can always change it later.
Remember, clients who are 55 years old are supposed to live at least another 30 years. Who knows what will happen in this country over the next 10, 20, 30+ years. We could have total financial ruin if our government doesn’t stop spending. If that happens, the government will look anywhere and everywhere for money — including at the estate tax exemption.
Be very careful when counseling clients to get rid of their life insurance policies. I know that many advisers will be tempted to use the estate tax repeal as an excuse to make money helping people sell their policies in the life settlement market. Fight that urge and do what’s in your clients’ best interest — which is to keep their policies.
Selling a policy because the estate tax exemption has been given a two-year bump is not prudent, and my prediction is that it will come back to haunt those who recommend it.