In the ever-changing landscape of estate planning, the current federal estate and gift tax exemption offers a significant opportunity for individuals to transfer property or assets without incurring federal estate or gift taxes. The Tax Cuts and Jobs Act of 2017 was a milestone, doubling the exemption from $5 million to $10 million per person and setting it to increase with inflation.
Presently, the 2024 exemption stands at $13.610 million, and it is expected to increase slightly for inflation in 2025. This is in addition to an annual gift tax exclusion amount of $18,000 per beneficiary this year. However, this substantial tax relief is not permanent since it is scheduled to “sunset” or revert to its 2017 level at the end of 2025 (increased to account for inflation), reducing the expected amount to between $6 million and $7 million. Those with estates larger than that will see those amounts mostly exposed to a 40% federal estate tax.
This situation presents an urgent need for individuals with sizeable estates to engage legal and life insurance professionals to assess their circumstances and formulate strategies to utilize their federal gift tax exemption. Although two years might seem sufficient for estate planning, many top estate attorneys are currently overwhelmed, servicing existing clients who are eager to make the most of the current exemption. The estate planning and insurance specialists at Cedar Point Financial Services LLC are ready to assist their clients and their other advisors in applying the exemption and addressing remaining estate tax obligations.
Dispelling Misconceptions and Urgency in Planning
There are misconceptions regarding the exemption. One is that the current exemption amount is 'grandfathered in' for those who have already utilized a portion of their exemption. This is incorrect. For example, if someone has used $10 million of their exemption by January 1, 2026, he or she will not be able to also use the approximately $4 million additional exemption available in 2025.
Another misconception is that one can apply the exemption amount from the top down. This approach is not feasible, and any remaining exemption will not be preserved post-sunset.
As the sunset approaches, it’s crucial for those who haven't utilized their exemption to act promptly to minimize future estate taxes. Cedar Point Financial Services LLC invites those with questions about their lifetime federal gift and estate tax exemption to contact their team today.
Leveraging Life Insurance in Estate Planning
A common strategy in estate planning for applying the federal gift tax exemption starts with establishing an irrevocable trust, with the individual or married couple establishing the trust serving as the grantor(s). Ideally, assets that are likely to appreciate or are eligible for valuation discounts, like business interests or minority stakes in partnerships, are transferred to the trust using the exemption, thus removing them and their appreciation from estate taxation.
A key opportunity is the use of cash gifted to an irrevocable trust to purchase a life insurance policy. The policy is typically on the life(ves) of the grantor(s). At the death(s) of the grantor(s), the policy’s income tax-free death benefit can provide valuable liquidity to pay estate tax obligations. While the grantor(s) is(are) living, the cash value within the policy enjoys tax-deferred growth and can be accessed via tax-preferred or tax-free distributions to meet any need for liquidity. The tax-free growth of the policy’s cash value is particularly beneficial for grantor trusts, where the grantor is liable for taxes on trust income.
Depending on asset performance, interest rates, and the amount of cash in the trust, it might be more advantageous to borrow against trust assets for life insurance premiums, rather than liquidating them. Another method is to finance premiums by using the policy or other assets as collateral or by using inter-family loans or split-dollar arrangements. These borrowing strategies can offer a more cost-effective approach than direct premium payments.
At Cedar Point Financial Services LLC, we take into account each client’s unique financial situation and will explore a multitude of premium payment strategies to ensure adequate life insurance coverage is secured.
Case Study: Meet the Wentworths
Ted and Stephanie Wentworth are a couple in their ‘60s with a $50 million net worth and two adult children and several grandchildren. To manage their potential 40% estate tax, their trust and estates attorney first establishes an irrevocable trust. They then use their 2024 combined exemption to transfer $27.22 million into the trust, consisting of cash and other assets, which reduces their taxable estate to approximately $23 million.
To cover estate taxes at a 40% rate on this amount, the trust purchases a $10 million second-to-die life insurance policy with an increasing death benefit. This ensures that the policy’s future proceeds will continue to grow along with the Wentworths’ estate and corresponding estate tax liability, permitting their children to pay those taxes without having to liquidate other assets.
After Ted and Stephanie both pass away, the policy’s death benefit will be paid to trust and distributed as needed to meet estate tax obligations and to provide liquidity for other needs.
Use It or Lose It
The current federal estate and gift tax exemption represents a peak in estate planning opportunities. With the exemption set to decrease significantly after 2025, the urgency to devise and implement an estate plan is paramount. Consulting with a team of professionals, which includes a trust and estates attorney, an accountant skilled in personal planning and business valuation, and a life insurance expert from Cedar Point Financial Services LLC, is the best course of action to effectively address estate tax concerns.
Procrastinating about or delaying planning can be especially problematic, since your estate planning attorney may not have time for you as the sunset draws near. The estate planning attorneys with the top firms and best reputations will have their hands full with other clients in similar situations seeking to apply their exemptions.
In addition, clients who need soup-to-nuts estate planning, will further exacerbate this traffic jam. As most who work with attorneys on estate matters know, estate planning can take many months and not just a couple of weeks. Making asset transfers to an irrevocable trust (if the trust has been established) involves selecting assets, retitling ownership, interaction with the trustee and a great deal of legal work. These reasons clearly should prompt action toward using an exemption sooner than later.
Here to Help
As we face the impending changes in the federal estate and gift tax exemption, the need for timely and effective estate planning is clear. The integration of life insurance into these plans offers a strategic approach to manage potential tax liabilities, while ensuring the preservation of wealth for future generations. The current exemption level provides a unique opportunity, but the window is closing rapidly. Engaging with skilled professionals such as those at Cedar Point Financial Services LLC to navigate these complexities is imperative for those wishing to maximize their estate's value for their beneficiaries.