Preparing for Tax “Reform”Submitted by AdvisorServe on February 9th, 2021
Preparing for Tax “Reform”
We all know that tax law could change significantly following the 2020 election. There may not be a lot of good news for most working Americans. Specifically, anyone earning more than $400,000 per year probably sees that red dot from the government’s laser guided weapon sitting squarely on their chest (they can’t see the one aimed at their back). But they are not the only ones being targeted. Families who think they have a net worth lower than what will be exposed to estate tax may have rude awakenings. And people who plan to sell capital assets like stocks or real estate may also find higher taxes eating into their profits.
But wait. This could become the greatest opportunity advisors have been offered in decades. After all, what business are we in? When tax exposure grows, so does the need for good advice. History tells us that people do not keep doing the same thing when external events impact their lives. Yes, it may be more difficult to take home what might have been taken in years past, but good advisors will be ready to defend their clients through wise counsel and creative responses.
AdvisorServe is already gathering information on pending legislation and connecting with groups and organizations that are anticipating changes and creating effective responses. Yes, the fight for the well-being of our clients is fully under way. Here are some preliminary expectations and responses:
1) Higher income tax brackets – Restructuring compensation could be an effective way to realign higher income into tax favored strategies such as split dollar insurance and deferred compensation.
2) Higher capital gains rates – Charitable remainder trusts will likely become more attractive, and the use of accumulation life insurance will gain attractiveness over typical brokerage accounts. Remember, cash value policies grow tax free and can deliver tax free cash flow from the policy through return of basis or loans
3) Reduction of estate tax exemption – Recent smaller tax reform proposals used the reduction of the estate tax exemption as a way to pay for other changes that would cost the government money. With a sunsetting of the large exemptions already planned for 2025, moving that date earlier is a very easy thing to do. We fully expect more people to realize their need for estate planning, exploring solutions with life insurance funding, creative use of trusts, and charitable designs.
4) Reduction of tax free gifting window – Premium financing arrangements and private split dollar will leverage the amount that can be transferred without paying gift tax.
5) Loss of step-up in basis – Estate planning will have greater focus on capital gains taxes as well as estate taxes, demanding new approaches to transfers and again more tax free life insurance
6) Lower limits on generation-skipping – Again, life insurance can easily patch the new gaps. Premiums on life insurance can be gifts delivering significantly leveraged death benefits. For example, a gift of $1,000,000 cash to a trust might grow over time to a larger amount, with taxes eroding the results. However, a gift of $1,000,000 premium can deliver an immediately leveraged, higher death benefit with no taxation along the way.
It is too soon to tell how the rules will be changed. Just rest assured, there will be very effective ways to address any changes in tax law. Perhaps a key aspect of the strategies we expect to see is the strong position held by life insurance. With its tax-free cash value build-up, ability to draw tax free cash through return of basis or policy loans, and tax free death benefit, life insurance will continue to offer the perfect platform for many of the solutions that are developed.
Once an advisor identifies a need for life insurance to cover a particular risk, the primary unknown is whether such coverage will be available due to insurability requirements. For that reason, advisors would be wise to not put off seeking life insurance coverage whenever the need arises. Few of your clients are getting any healthier. Many could encounter health issues this year and be closed out from the valuable solutions offered by life insurance. We see this happen every year. Some clients have actually considered buying term insurance just to capture insurability with the option to convert later when permanent coverage is needed. The point is that there is little to gain by delaying when making insurance decisions.
With life insurance emerging as a key part of the solution, AdvisorServe intends to be a valuable resource for you as you guide your clients. Please contact us any time you think we can help. We are happy to help you assess the pricing that would apply to any client, especially those with any health issues. We also expect to alert you to the upcoming strategies as things develop in Washington.