The recent overhaul of the tax code has many repercussions—not the least of which may be the doubling of estate-tax exemptions and its effect on life insurance.
The estate tax is levied on wealth transferred through inheritance. Before the tax overhaul, estates worth less than $5.5 million were exempt from that tax. Now, however, the exemption is $11 million for individuals and $22 million for couples.
This increase has led some advisors to tell their clients to consider giving up their permanent life insurance policies. They may no longer need them, the reasoning goes, to aid their heirs in paying the federal estate tax.
But other advisors say not so fast.
"First, some states still have estate taxes," said Herbert K. Daroff, an attorney and financial planner at Baystate Financial Planning in Boston. "Second, the largest tax bill that most heirs will pay is the federal and state income tax on retirement accounts," not the estate tax.
Furthermore, the doubling of the exemption isn't permanent, noted Martin M. Shenkman, an estate planning attorney and founder of Shenkman Law in Fort Lee, N.J.
Indeed, the exemption will be reduced by half in 2025. Even before then, a new presidential administration or Congress could well make other adjustments. "So think carefully before making a change," he advised. “All policies should be reviewed and evaluated for current benefits. In many cases, existing policies can be repurposed to meet needs other than just paying estate tax."
One of those potential other needs is liquidity, he said. Even if a client isn't concerned about the estate tax, many life insurance policies can provide cash to beneficiaries more readily than other types of assets. "Clients owning real estate or business interests or art still need life insurance for liquidity," Shenkman elaborated.
Life insurance can also "equalize estate distributions," he said. That's especially important if heirs don't want to share their inheritances—if there are children from a previous marriage, say, or if the heirs simply have different interests. For example, the child who is involved in the family business can inherit the business while the other who is not can receive an equivalent amount of cash from insurance. "The uses are almost endless," said Shenkman.
In any case, clients can cash in on life policies without getting rid of them. Whole life policies are mostly paid for up front, but clients can still cash in. "They can borrow against the cash value, typically accessing 80% to 90% of the cash value," said Daroff. He noted, though, that, "Upon surrender, they may have an ordinary income tax gain, if the cash value is greater than the premiums paid."