Tax Reform’s Impact on Tax, Life Insurance, Pension, and Estate Planning
One of the Most Impactful Changes Made Under the Tax Cuts and Jobs Act of 2017 (Act) Pertains to Estate and Gift Tax Law.
Under the Act, estate and gift taxes remain in place, but exemptions were raised to $11,180,000 for individuals and $22,360,000 for married couples. Those exemption levels expire in 2025, when they will revert to current levels (unless new law is enacted). Those levels are indexed again, but this time to the “chained” CPI index, which is lower. Calculations performed with this new index predict $6.3 million/$12.6 million exemptions in 2027. As part of the Act, the federal estate tax rate remains at 40 percent above the exemption. The gift tax stays at 40 percent.
The implications of all this are multifaceted and impact wealth and estate tax planning to varying degrees. We offer some key takeaways below as they pertain to personal wealth management, corporate and individual planning, life insurance planning and pension planning strategies.
GENERAL PLANNING TAKEAWAYS
- Heirs/designees of individuals who die in the next eight years will be subject to lower federal estate taxes.
- State estate taxes will still apply and remain at considerable levels in a number of states.
- Coupled with the $10,000 limitation on the federal deduction of real estate taxes and state income taxes, there may be a further physical migration to lower-tax states.
- The gifting exemption is also raised to the estate tax exemption limits cited above (i.e., $11,180,000 for individuals and $22,360,000 for married couples). This increased limit provides a planning opportunity for affluent individuals to make additional gifts to children and trusts. This is a “use it or lose it” provision; waiting until 2027 would allow the gifting amounts to revert to lower limits. There does not appear to be any “clawback” provisions in the new law.
- Gifting opportunities can also be coupled with existing techniques (e.g., discounting, GRATs, Intentionally Defective Trusts, CLATs) that were left untouched in the new tax law. These can provide even more leverage for gifting. Generation Skipping Trusts (GST) will be utilized more thoroughly in conjunction with the increased gifting limits.
CORPORATE AND INDIVIDUAL PLANNING TAKEAWAYS
- Eight-year Grantor-Retained Annuity Trusts (GRATs), designed to “roll out” before the new federal estate tax threshold expires, could be very effective in moving wealth to the next generation, with less risk of federal estate taxes in the event of a death during the GRAT term.
- There will be a swift return to “loan regime” split-dollar insurance programs for all corporations, since corporations will be more lightly taxed than previously and will benefit from substantially lower rates than individual tax rates. This provides a big planning opportunity for corporations via split- dollar, since the employer is “lending” money to the employee, and the low interest or economic benefit is the imputed cost.
- There will be a reduction in existing and newly implemented “executive bonus plans.” The deduction to the corporation is worth less, and the bonus will be taxed to the employee at a higher level than in the past. Many executive bonus plans will morph into split-dollar or deferred compensation plans.
- No longer will pass-through entities have to shy away from split- dollar plans; there is still tax leverage to be gained. Trusts can also leverage the new pass-through taxation rules.
LIFE INSURANCE PLANNING TAKEAWAYS
Life insurance will play a larger role in individuals’ overall financial portfolio due to tax savings, asset protection, income withdrawal ability, and reduced Alternative Minimum Tax (AMT) exposure. Life insurance as an “asset” class will be a more common term utilized by financial advisors.
Additionally, acquiring life insurance within a corporate structure will exhibit new advantages, while still maintaining the existing ones.
- Accumulating monies within the insurance policy cash value will be even more tax advantageous.
- With corporations no longer subject to AMT, the extra tax drag on death benefits applicable to corporate-owned policies will disappear. Think key person, deferred comp, buy/sell coverage, all corporate-owned policies, etc.
- Deferred compensation in nonqualified plans will experience a resurgence. In the original House and Senate tax reform drafts, nonqualified deferred compensations would have been eliminated. Even existing plans would have gone away. Heavy lobbying occurred for that provision to be removed from the bills.
The bottom line is that life insurance expense will be less costly under the lower corporate brackets.
PENSION PLANNING TAKEAWAYS
- It’s likely that more Roth IRA conversions will occur, due to lower individual rates.
- If charitable contributions are discovered to have an “elastic” economic demand component correlated with the value of tax deductions, you may see a trend towards lower charitable contributions.
- Employees with the flexibility to change to a 1099 status may incorporate to take advantage of the new tax brackets and pension opportunities. However, they may be putting their healthcare and qualified benefits at risk by doing so and would have to acquire their own.
All takeaways in this article represent educated opinions, and we certainly welcome any comments you wish to share. We will continue to closely monitor the landscape and keep you updated as developments occur. In light of the Act and its many ramifications, all life insurance policies, corporate and individual, should be reviewed along with their corresponding agreements and trusts.