“Use it or lose it.” That’s the message estate lawyers and financial advisors are giving their clients regarding the estate and gift tax exemption. Estate tax limits established under the Tax Cuts and Jobs Act are set to be cut in half at the end of 2025. More urgently, the ongoing pandemic means Congress will have to find funds to cover the country’s already massive COVID-related spending, and the estate tax is a prime candidate for that.
So there’s a good chance you and your advisors will soon be exploring gift and estate planning techniques that lock in the current exemption, not least making gifts to trusts. While you’re at it, we suggest you talk with an insurance professional about the benefits of incorporating life insurance into those plans.
Families that are successful enough to have to worry about estate taxes don’t usually think much about life insurance, assuming they don’t need protection against unexpected income loss. And even those who recognize the tax-free investment benefits of life insurance often don’t understand the full extent of its potential. At Alliant, we take the time to get clients thinking differently because there are compelling reasons for families—yes, including the wealthiest—to exploit this under-utilized investment when putting together their estate plan.
ACHIEVING MAXIMAL TAX EFFICIENCY OF YOUR ESTATE
First some math: Currently, the lifetime gift and estate tax exemption is at an all-time high of $11.58 million. Any amount over that is subject to the gift tax (at the same rate as the estate tax, 40%), unless it is drawn down against that $11.58 million. For example, if you give your heirs $5 million tax-free today, that leaves exempt $6.58 million more of your eventual estate under current laws. Keep in mind that doesn’t include annual gift exclusions: $15,000 or $30,000 per couple, which you can give tax free to as many people as you want. While lifetime gifting provides value only if it grows, annual gifting does offer immediate value. But there is potentially much longer-term value to be gained by putting it in a trust and investing it wisely. Here’s where life insurance can play a role.
While other investments require time to grow; insurance does not—it’s worth the full value with the payment of a single premium. Further, the return on that investment is tax free at competitive rates. Better yet, it isn’t taxed as it grows, unlike most other investments that create tax along the way. Further, it receives a “step-up in basis” at your death, so heirs won’t pay capital gains taxes when the policy pays out as they would, if they inherit from a more traditional investment instead.
LIQUIDITY TO COVER ESTATE TAX BILLS
If most of your estate is in the form of real estate or a privately held business, your heirs may not have the readily available cash to pay what could be a hefty estate tax bill, due within nine months of your death. This could force heirs to sell off assets—some which they might otherwise have kept—quickly and even potentially at a below-market price. A life insurance policy provides the necessary liquidity to pay the tax bill without forcing their hand.
LEAVING A LEGACY
Your heirs are sure to receive the full amount of a life insurance policy upon one’s death, and some people use this guarantee to enable a “guilt-free retirement.” With children provided for by the payout, parents can spend other assets however they want. Similarly, in second marriages with children from the first, life insurance is a simple way to leave a legacy, while leaving assets to a spouse.
An Attractive Return
How good an investment is a life insurance policy? To calculate that, assume you have the average life expectancy of someone your age and gender. In today's market, the effective annual returns for life policies using this assumption is between 4% and 6% tax-free. That’s the equivalent of a taxable investment with a 6% to 8% return— better than the yield of many other low-risk investment options in the current environment.
Indeed, the effective returns alone suggest that you should be considering life insurance as part of your estate plan. Add in its other benefits—comes unburdened by capital gains, requires no time to reach its full potential, and offers guaranteed returns—and a life policy becomes even more intriguing. That said, everyone’s situation is unique. Because of that, nothing can replace the advice of a skilled estate tax lawyer and investment advisor working alongside a knowledgeable insurance professional. We have spent decades advising some of the world’s most successful people on the best ways to incorporate life insurance into their estate plans. We would be delighted to answer your questions and to share our experience with you and your trusted team of professional advisors.