It has been more than two and a half years since presidential candidate Joe Biden released his tax plans, leading to uncertainty around personal tax rates as well as several common estate planning strategies and structures. President Biden’s initial legislative package, the Build Back Better (BBB) Act, provided some clarity for those needing to plan for wealth transfer and estate liabilities, but was rife with significant tax increases as well as provisions that lessened the impact of grantor trusts.
When the BBB Act failed to move forward, planning paralysis spread as Americans waited for replacement legislation – legislation that arrived in the form of the recently enacted Inflation Reduction Act (IRA) of 2022. The good news is that the IRA will have little impact on personal tax rates and the ability to carry out well-established estate planning techniques, including the use of life insurance to protect and grow legacies. Cedar Point Financial Services LLC works with its clients and their advisors on four primary ways life insurance is used in estate planning.
#1. Estate Tax Mitigation
Federal estate taxes can consumea significant percentage of an estate and must be paid in cash within nine months of a death. Too often, it is the estate’s personal assets that are used to cover estate tax debt. This may be especially challenging when an estate’s assets, such as an interest in a family business, a personal residence, or an investment portfolio, cannot be easily liquidated on such short notice, or if the heirs would rather not sell these assets so they can remain intact.
Proceeds from a life insurance policy are typically received income tax-free and could be used by beneficiaries to immediately pay estate taxes while preserving assets. Structurally, this is accomplished by setting up ownership of a life insurance policy in an irrevocable life insurance trust where the policy’s death benefit is held outside of an estate. Premiums for the policy are gifted to the trust using one’s annual gift exclusion amount ($16,000 per beneficiary in 2022) or some or all of one’s lifetime federal estate and gift tax exemption amount.
Currently, this lifetime exemption amount is $12.06 million per person. However, it is important to note that although this amount will be adjusted annually for inflation, the IRA did not change existing legislation that will “sunset” this amount at the end of 2025 back to just over $5 million per person. The planning experts at Cedar Point Financial Services LLC encourage their clients to make use of their lifetime federal estate and gift tax exemption to move assets out of their estate before it is too late, and before their allowable exemption has been significantly reduced.
An alternative structure that protects each spouse’s access to a married couple’s assets is the spousal lifetime access trust (SLAT). By establishing an irrevocable trust for the benefit of the other spouse and funding each SLAT with marital assets and a life insurance policy, both spouses can enjoy all their assets that are held outside of their estates (albeit careful design by a qualified attorney is needed to avoid any reciprocal trust doctrine issues). Then, at the death of either spouse, life insurance proceeds can replace the wealth lost from the transfer of assets to heirs.
#2. Preserving Family Assets
Most family businesses are started with a dream and built with hard work. It is not unusual for the value of these businesses to comprise most of a family’s wealth, so it is imperative that an estate plan consider the future of the family business. In doing so, it is important to recognize that not all family members are a fit to work in the business or to inherit it.
By incorporating a continuity plan that is funded with life insurance, families can use insurance benefits to equalize inheritance for heirs who are not included in the business, preserving family harmony while protecting the viability of the business. Insurance proceeds can also be used to retain and motivate key, non-family employees so that business operations continue to run smoothly during what may be a difficult transition.
#3. Estate Liquidity
Even with a robust estate plan, it could take a great deal of time before money is released and distributed to loved ones. Liquidity will likely be needed for short-term income to meet living expenses and to maintain a residence and other properties, service business debt, fund education expenses and estate taxes. These expenses can place financial burdens on those left behind, even forcing them to sell their own assets or to go into debt to meet these obligations. Funds from a life insurance policy can help immediately pay for these expenses by passing along an income tax-free death benefit.
#4. Avoid Probate
Life insurance has the unique ability to create an immediate estate for beneficiaries after a death, often for pennies on the dollar. It allows cash to be passed directly to the designated beneficiary, essentially bypassing the complications created by probate. Moreover, the benefits are distributed tax-free and remain untouched by potential debts. Life insurance removes the uncertainty probate can create.
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The IRA provided the long-awaited clarity needed for effective estate planning. Tried and true strategies remain intact, and currently the federal estate and gift tax exemption amount remains high. This is the platinum age of estate planning! At Cedar Point Financial Services LLC, our team can assess how life insurance can mitigate future estate taxes, protect wealth from erosion, safeguard a family business and avoid probate.