House Democrats’ tax proposal could affect life insurance for the rich

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Life insurance planning for wealthy Americans could be turned upside down by a proposal in the Democrats’ tax reform package.

The House Ways and Means Committee passed measures on Sept. 15 that would raise an estimated $ 2.1 trillion in taxes from businesses and the wealthy, to help fund President Joe Biden’s economic agenda.

One rule would limit one type of trust (a transferor trust) that the wealthy use to protect their estates from tax on death and pass more money on to heirs.

If passed, the rule could change the way multi-million dollar estate owners buy life insurance. They often hold their life insurance policies in trusts targeted by the House proposal – which, if it becomes law, can result in a big estate tax bill down the road, experts say.

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“I think most life insurance trusts would be affected by this proposal,” said Beth Shapiro Kaufman, estate planner at the law firm Caplin & Drysdale.

Insurance planning

A life insurance trust acts as an intermediary – it routes the insurance payment to beneficiaries, such as a spouse or children, upon the death of the buyer.

These trusts can also generate tax savings. They withdraw the insurance benefit from the taxable estate upon death.

For low and middle income earners, this type of planning is usually not a concern. Estates owe tax (a 40% federal rate) only if their cumulative property exceeds $ 11.7 million in value, or double for married couples.

But for the wealthy, the financial benefits of life insurance trusts can be significant.

Here’s a simple example: A person dies with $ 10 million in real estate and investment accounts and $ 3 million in life insurance. The person’s estate would owe $ 520,000 in federal tax (or 40% of the value greater than $ 11.7 million) if the policy was not in trust; it would not be liable to tax if it were held in trust.

These trusts are often transferor trusts, according to estate planners. This mechanism allows buyers to make payments to the trust each year to cover annual insurance premiums, they said.

However, the House’s tax proposal and current estate rules are such that if the legislation is successful, life insurance in a grantor trust would become part of the estate taxable on death, nullifying the aforementioned tax benefits, according to David Herzig. , a tax director with Ernst and Young.

I think most life insurance trusts would be affected by this proposal.

Beth shapiro kaufman

real estate planner at Caplin & Drysdale

(The legislation would also lower the threshold for inheritance tax assets to $ 5 million per person, meaning that more of the estates of existing taxpayers would be subject to tax.)

Of course, the proposal is not final. Democrats have yet to reach consensus on the comprehensive package amid disagreements over its content and scope. The grantor-trust provision can be omitted or changed in a tax dossier released by Senate Democrats.

Some planners believe there would be ways around the rule even if it became final.

“It’s a problem that can be solved,” said Robert Lord, lawyer for Americans for Tax Fairness, a progressive group.

For example, the wealthy may be able to change their trusts to evade House rules, he said.

Others are skeptical of how easily this can be accomplished. For example, it could mean that the rich can no longer make annual contributions to pay insurance premiums or risk triggering the tax.

“There is an esoteric question of, could you actually create trust?” Herzig said. “At best, it’s uncertain at this point.”

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