Three solutions for estate tax uncertainty

By Jeff Reed

Kestler Financial Group


In our last discussion about President Obama's 2014 proposed budget, I wrote that changes to estate tax law included in the American Taxpayer Relief Act of 2012 are anything but permanent. In fact, they might not last more than a year if Mr. Obama has his way.

The challenge is, what to do about it?

The public, based on the relative lack of large, lifetime-gift-focused transactions late last year, is not all that concerned. At the very least, they're not concerned enough to make the commitment necessary to execute on a large gift.

Rather, they are electing to "wait and see" yet again. We all know that approach can create some challenges downstream. The question for us as advisors is how to find some middle ground and protect our clients from themselves.

Here are three possible solutions for this situation:

Solution 1: Term insurance

This solution is rather obvious. Spend a little, protect against future changes in health and have the ability to convert to permanent should the estate tax landscape change.

Of course, this is also a very flawed strategy. The gaping hole is the lack of certainty about what products will be available in the future and the cost associated with them. All the product changes in our business over the last 12 months drive this point home.

Further, the conversion period is limited, lasting only 5 to 10 years for most contracts — simply too limiting in my view.

Solution 2: Wait-and-see policy design

This solution takes everything that is solid about solution one and eliminates the flaws.

Rather than buy term insurance, how about we go ahead and lock in permanent coverage, but limit our financial commitment to the absolute minimum?

Let's assume that a male age 65, standard nonsmoker, with a need of $5 million, 10-year term insurance costs are roughly $41,000, for a total outlay of over $400,000. If we add his wife, also age 65 and standard nonsmoker, to the equation, we can provide the same coverage with a 14-year duration for a total outlay of $236,000 over three years.

The real benefit of this, however, is that this is a permanent product, and rather than any kind of conversion exercise, the client need only resume funding at any point during the first 14 years to extend the coverage. With younger clients, the duration can be as long as 18 years!

By now, most of you see the one large client objection still facing us: Even with the drastic reduction in premium, we're still talking about a serious chunk of change. And if there are no changes to the current law, the client is out that money.

From my perspective, there are really two ways to handle that. The first looks back at solution number two. With proper design, we can hit tax equivalent IRRs at life expectancy as high as 11 percent.



If the client is serious about growing their net worth and maximizing their legacy regardless of tax law changes, the design described above is certainly a viable choice.
Solution 3: Wait-and-see with an exit strategy

There are those clients, however, that simply do not want to purchase the insurance unless they know there is going to be a tax. Those clients typically want to deploy their money in other asset classes, and we can give them that option, provided they can defer their ultimate decision on the insurance for at least 10 years.

This option takes a bit more premium — $356,000 in this scenario — but the client has contractually guaranteed options at year 10 and 15 to surrender the contract for 90 percent or 100 percent of premiums paid, respectively, reducing their cost to the time value of money over that period.



That is the "cheapest" insurance you will ever buy, guaranteed.