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Five Strategies to Mitigate the Impact of Tax Increases with Life Insurance

Five Strategies to Mitigate the Impact of Tax Increases with Life Insurance

July 27, 2021

Increases to personal, business, and estate taxes have been proposed and life insurance is a powerful, yet often overlooked tactic to replace income and protect wealth from being eroded by rising taxation.  President Biden and Congress have proposed significant tax policies which could impair your ability to save for retirement, grow your business and pass along an inheritance to children and grandchildren. Some of the proposals include:

  • Increasing the top ordinary income tax rate on income over $400,000 from 37% to 39.6% and adding a 12.4% Social Security payroll tax, split between the employee and employer, for wages over $400,000
  • Moving the long-term capital gains tax rate from 20% to 39.6% plus the 3.8% Net Investment Income Tax for taxpayers with more than $1,000,000 in income.
  • Eliminating the step-up in basis of property inherited at death and replacing it with a carry-over basis with a $1 million exemption per individual and an additional $250,000 for a home.
  • Limiting the tax benefit of deductions for a retirement plan contribution to 28%.
  • Boosting the corporate tax rate from 21% to 28% and limiting the Section 199A Qualified Business Income deduction for pass-through business owners earning more than $400,000.

Here are five solutions utilizing life insurance strategies that you and/or your business can use to offset the impact of tax increases.

1) Increase funding and boost the efficiency of your qualified retirement plan with a Split-Funded Defined Benefit Plan.

A Split-Funded Defined Benefit Plan is a special type of qualified retirement plan.  The ‘split’ means that the funding the plan takes advantage of both cash value pension life insurance (that has unique attributes) and other investments.  As a business owner, this Plan provides the opportunity to make significantly larger tax-deductible retirement contributions while protecting your retirement assets from creditors.  In the back end, the pension life insurance can be prioritized to provide a tax-free stream of income for yourself or to maximize tax-free death benefit for your heirs. Cedar Point Financial will help you discover how to take advantage of all the benefits of a Split-Funded Defined Benefit Plan

2) Put the money in your profit-sharing plan to work creating funds to replenish transfer taxes by purchasing life insurance with pre-tax dollars.

A properly designed profit-sharing plan may purchase and own life insurance on you as a participant.  By doing so, the policy is purchased with pre-tax dollars with either a single premium payment or a small number of premium payments in order to maximize the amount of death benefit.  Once in place, the policy can later be purchased tax free by you or by your grantor trust at the fair market value of the policy, typically at a favorably discounted amount.  The result is a fully funded policy purchased tax-efficiently that you can use to replace wealth lost to taxation.  Cedar Point Financial will evaluate your unique planning needs to determine if this solution will help you meet your financial goals.

3) Use your Individual Retirement Account (IRA) or Defined Contribution Plan (DCP) funds to fund a life insurance policy to maximize after-tax values to heirs

The recently passed SECURE Act now precludes IRA and DCP account holders from stretching distributions beyond 10 years for most beneficiaries (abolishing the “Stretch IRA”).  This means that distributions from inherited accounts must be taken faster, be larger, and potentially be subject to higher tax rates, leaving less for your children and grandchildren.  By taking distributions today and using the after-tax dollars to fund a life insurance policy, you can replace IRA and DCP distributions lost to your heirs by the impact of the SECURE Act with an income (and perhaps estate) tax-free death benefit.  Cedar Point Financial will show you how to counter the erosion of your IRA or DCP balances due to confiscatory taxation.

4) Leverage your C-Corporation for more retirement savings or to enhance your estate plan through a Split-Dollar Plan. 

A Split-Dollar Plan uses corporate dollars taxed at a lower rate than your personal one to fund a life insurance policy you own and can draw on for retirement income or to maximize death benefit in conjunction with your estate planning.  The ‘split’ in the strategy comes from the division of the premium payment – with most of the funds being loaned by your C Corporation and you personally being responsible for income taxes on a comparatively small economic benefit.  Cedar Point Financial can determine if you can be obtaining more value from your business for your personal planning needs.

5)  Allow you and your key employees to save with an Executive Bonus Arrangement.  

Just like you, your key employees will feel the impact of higher taxes. Qualified retirement plan funding limitations only exacerbate the problem. An Executive Bonus Arrangement allows an employer to use a portion, or all of the funds earmarked for a bonus to fund a life insurance policy designed to optimize its cash value and maximize tax-free retirement income. The policy is owned by the employee who may later access it for supplement retirement income. As the employer, you not only get a tax deduction but can put restrictions as to when an employee can access the policy’s cash values, creating a “golden handcuff” reward and retention device. Cedar Point Financial can assist in helping you tax-efficiently retain and reward your key employees.

You don’t have to just accept tax increases; you can do something about it. Let Cedar Point Financial Services LLC show you how life insurance can mitigate rising tax rates.