You never know what is on the horizon but you can be prepared

Separating Life Insurance Sales from the Estate Tax Planning Myth: Where We’ve Been, Where We’re Heading

Amanda J. Capps, JD, LLM

Estates, inheritances, heirs, any of these terms can conjure up dramatic imagery ranging from the Rockefeller family to the Vanderbilts. These names traditionally related to powerful, influential people, characterized by unlimited wealth and resources (along with their substantial contributions to the fabric of the United States). It should, likewise, surprise no one that the United States Congress has sought to levy a tax on this accumulation of wealth consistently for decades, and not just through income taxation.

For the past 100 years, the Federal Government has relied on “death taxes” as sources of revenue.  And the motivations behind collecting this revenue have ranged from funding military operations (The Stamp Tax of 1797; The Revenue Act of 1862; The War of 1898) to a “progressive” and possibly “populist” agenda, aimed at preventing the concentration of wealth in the hands of a limited number of newly-minted industrialist families (the modern estate tax circa the Revenue Act of 1916). In one form or another, the modern estate tax system has persisted since the early 1900’s. This is in spite of threats of repeal, one actual year of estate tax repeal (2010), and multitudes of increasingly bizarre and complicated “tinkering” with what we now know as a three-part system of federal estate, federal gift, and federal generation-skipping transfer taxes. We can also look to a multitude of states, which now charge a separate, state-level estate tax.

While the first instances of the federal government taxing an estate (establishing a tax for a stamp on a valid will offered for probate) likely dovetailed with the establishment of the legal profession in the early colonial history of the United States, the role of qualified “estate planning professionals” has only expanded. Be it an estate planning attorney, a CPA, or a personal Financial Advisor, all of whom have expanded their offerings in this direction over the decades.  Wealthy families have options at their disposal to plan to “minimize” the impact of transfer taxes on the legacy they would like to preserve. And these services are not only available to the wealthy. While estate tax exemptions have greatly fluctuated over the years, taxing accumulated wealth way south of $1,000,000, it has also become important to most average Americans to “get their affairs in order” and look at basic wills and trusts, beneficiary designations, and funding mechanisms to make sure they have some control over establishing their own, personal legacy.

Lying within the toolbox of every astute planning professional is life insurance. While the Presbyterian Synod of Philadelphia sponsored the first life insurance corporation in America for the benefit of Presbyterian ministers and their dependents in 1759, many of today’s largest life insurers were formed during the 1800’s, including New York Life, John Hancock, and Prudential. Life insurance sales rose dramatically after World War I, peaking at $117 billion in force by 1930. Life insurance has since played an important role in society, helping families cover the “costs” associated with death, from funeral expenses to income replacement and college education. One of those very demonstrable costs has obviously come to include replacing the wealth lost to transfer taxes, and seemingly more so in years with a very low federal estate tax exemption rate.

Life insurance benefits have long been tax-free to beneficiaries (IRC Sec. 101(a)), provide “instant” cash liquidity on death (they aren’t subject to the arduous probate process), and, unlike stocks or mutual funds, the payout to heirs is largely unrelated to market performance.  Life insurance can also provide leverage; the owner/insured pays a relatively small premium in comparison to a relatively large death benefit. However, it is worthy to note that these benefits of life insurance exist regardless of the status of the federal estate tax. Just as “estate planning” is a process every American can (and should) engage in, life insurance should be part of the estate planning process for every American, regardless of whether the federal estate tax applies.

Accordingly, today’s federal estate tax only implicates a very small number of estates in value over $10.98 million dollars. Per a 2015 report from Congress’s Joint Committee on Taxation, 4,700 estate tax returns reporting tax liability were filed in 2013, out of 2.6 million total deaths. That means the estate tax hits roughly 0.2% of Americans, or 1 out of every 500 people who die.[1] As has been widely reported, President Donald Trump, possibly splitting from a “populist agenda” has introduced proposed legislation aiming to double that exemption amount and eventually repeal the estate tax altogether in 2024. Likely less than 1,000 estate tax returns will be filed per year with a tax due if the Act becomes law.[2] While it remains to be seen what aspects of Trump’s tax plan will be enacted, and for how long they will even remain part of the Code, if the past 100 years have taught us anything, the “death tax” is more like a zombie– unlikely to remain dead.

Death itself does, unfortunately, remain an inevitability we all must face. Every one of us will leave something behind, whether or not it’s taxed by the federal government.  Ideally, estate planning is a process that doesn’t rely on estate taxes. Life insurance is an integral part of that holistic process, and provides benefits that far outstrip paying one bill. We should all keep this in mind as we continue to serve our clients in the best manner possible.