Navigating Planning Issues in 2017

By Brett W. Berg

Life insurance can be a key part of any needs-based discussion of estate and family business planning with your clients.

The last presidential election may prove to be one of the most surprising upsets in history and will most likely usher in a fluid tax environment in 2017.

As the dust settles, financial professionals will play an important role in helping families and family businesses better understand and navigate the changing landscape. When it comes to the needs-based discussions around estate and family business planning, life insurance in particular can be a critical part of this conversation.

Here are some of the potential tax proposals to watch for in 2017 and key ways to use the tax efficiencies of life insurance to help (1) minimize family conflicts, (2) ensure flexibility for changing needs over a lifetime, (3) provide for survivor needs and (4) manage wealth and tax exposure for future generations.

Although we will not know the exact details of any changes in tax laws until after Congressional passage of any proposed legislation changes in 2017, some of the proposals President Trump has articulated in the past are significantly reducing marginal tax rates, increasing standard deduction amounts, repealing personal exemptions, rescinding the 3.8 percent Medicare surtax, capping itemized deductions and allowing businesses to elect expensing new investment instead of deducting interest expense.

Whereas Trump hasn’t specifically mentioned repealing the gift tax, he supports repealing the federal estate tax and, potentially, eliminating the current step-up in basis of appreciated assets at death. In essence, the president’s proposal replaces the estate tax with a capital gain tax at death. Importantly, the Trump proposal does not include language on eliminating gift taxes associated with transfers during lifetime.

While it is still very early in the new administration and the tax landscape remains fluid, there does not appear to be any talk of fundamentally changing the tax attributes of life insurance. The cash build-up in life insurance is tax-deferred, while insurance withdrawals are tax-free to the extent of cost basis in the contract.

Loans are generally tax-free so long as the policy is not classified as a modified endowment contract (MEC), and the policy is not lapsed or surrendered.

Additionally, the death benefit of life insurance is generally income-tax-free. These tax efficiencies are important to remember when considering how life insurance can help clients address major needs-based issues in estate and financial planning, regardless of taxes.

With the current environment in a state of potential flux, it will be important for financial professionals and their clients to keep their dialogue open around planning issues in 2017. This will be particularly important when discussing intergenerational transfer of wealth and family business issues. For these clients, four key pointers regarding life insurance come to mind:

1. Life insurance can help minimize family conflicts.

Even though the federal estate tax may be reduced or eliminated under the policies of the new administration, the need for non-estate tax legacy planning will continue. For example, in many family-owned businesses, the commitment and contributions the children make are not equal. Often based on age, some children may work longer in the business than other siblings and feel they have a greater stake. Other children may choose not to join the family business in order to pursue other careers.

A common problem faced by these business owners is equalizing an inheritance, especially for the children who are not actively involved in the business. Typically, for the children who are not in the business, life insurance provides a sum of money free from income tax, while those children who continue to run and earn from the business ultimately inherit it.

To be sure, this planning may not be exactly equal in monetary or opportunity terms. The objective is to be fair when attempting to equalize the inheritance based on the client’s overall transfer goals. Importantly, life insurance can go a long way in helping to minimize family conflict when a business is involved.

2. Life insurance can help ensure flexibility and address changing needs.

Life insurance, and especially permanent life insurance, remains an important tool not only to provide death benefit but also cash accumulation potential to help supplement retirement income or other unanticipated cash needs.

The tax deferral of any cash value build-up helps reduce the negative impact of tax, while the tax-free withdrawals, to the extent of cost basis, and loans, in certain situations, also demonstrate the tax efficiency of life insurance as a potential tool for supplemental income in retirement.

These features really form the foundation of the flexibility life insurance offers, which can help address a client’s changing needs over time. Of course, it is always best practice to remind the client to consult his or her tax advisor on this and other taxation matters to keep up-to-date on applicant tax laws.

3. Life insurance helps provide estate liquidity for survivor needs.

Estate liquidity is the core role that life insurance plays in providing for survivor needs — and its importance cannot be emphasized enough. Adequately projecting survivor needs for income replacement due to a premature death should be part of every conversation, and life insurance, whether term or permanent, can provide liquidity when it is needed the most.

4. Life insurance can help manage wealth and tax exposure for current and future generations.

Regardless of whether the federal estate tax is repealed or reformed, life insurance is, and will continue to be, a financial tool, especially when included in a trust as an important financial vehicle to help manage wealth and other types of tax exposure over the generations.

Life insurance has the same tax benefits when it is used in trust as when it is used outside trust — tax deferral of any cash build-up, as well as income-tax-free withdrawals and loans. The trust itself will help manage wealth for a variety of non-tax reasons, including protecting against the spendthrift tendencies of children, providing protection from the claims of creditors and directing the care of special needs children.

Every situation is different, and clients should always work with a team of advisors, including the financial professional and the client’s lawyers and tax advisors. The main point is that life insurance trusts will continue to be important for many clients even if the federal estate tax is repealed.

Clarity in direction does not equal certainty in outcome. Even the boldest fiscal plans are subject to compromise or a complete rollback of their provisions. The key for financial planners is to maintain flexibility for their clients, and the versatility of cash value life insurance can help maintain that flexibility.

Regardless of the outcome of these tax proposals, life insurance addresses certain core needs; namely, immediate and timely cash when a family or business needs it the most — during lifetime or afterwards. As such, life insurance remains a crucial financial vehicle that helps provide the type of flexibility and versatility many families require in their planning today and for years to come.

Brett W. Berg, JD, LLM, CLU, ChFC, is Vice President of Advanced Marketing at Prudential, where he provides thought leadership on advanced planning and speaks at industry and broker conferences on estate and business-planning topics.

<pull quote:>

Life insurance trusts will continue to be important for many clients even if the federal estate tax is repealed.