As many were departing for a long Memorial weekend, the Biden Administration released the long-awaited Green Book. Many of us in the life insurance side of the financial services industry have been talking and writing about Biden’s campaign promise to tax the wealthy by rolling back Trump’s tax cuts -specifically by reducing the estate and gift exemption and increasing the tax rates. At the same time, some acknowledged that Biden also promised to raise capital gains tax by eliminating the benefit of step-up basis at death, but many commentators acknowledged the difficulty of implementing such a change. Many believed rolling back the estate and gift tax exemptions and rates were more likely than the elimination of step-up in basis. Much to our surprise, the Green Book does not propose any estate and gift tax increase but proposes significant changes to capital gains taxation. Following is a summary of the capital gains proposal: Read Full PDF
Diversify Your Concentrated Position: Help lower volatility, increase portfolio predictability and potential reduce taxes
Written by Terri Getman J.D.*, CLU, ChFC, RICP, AEP (Distinguished)
A hallmark of wise planning is to diversify risk across a range of assets and asset types because any one asset or asset class might underperform in a given year. Diversification can help offset underperformance. This risk can be magnified when an individual has a heavy concentration in one stock or asset. While capital gain rates are currently at near-historic lows and the stock market at an all-time high now may be a time to consider repositioning because President Biden campaigned on increasing capital gains tax – both during life and at death. Where an individual has a life insurance need, a life insurance death benefit might also help add stability to an overall financial plan.
DID YOU KNOW?
- Too much of any one company’s stock increases your exposure to company specific risk and stock price volatility.
- President Biden campaigned on replacing the 20% capital gain tax rate with ordinary income tax rate of 39.6% for incomes of over 1 million and eliminating stepped-up basis at death.
MEET JOHN, CEO OF XYZ Inc. – Age 55, nonsmoker, in good health
John currently owns $2 million of XYZ stock (48,780 shares at $41 per share with a cost basis of $15.98 per share). He’s concerned that his current concentrated stock position exposes him to higher levels of market and price volatility. Based on his objectives, net worth, time horizon and risk tolerance, this large position is more than he is comfortable with. John receives $980,000 in wages.
Despite his continued interest in the market returns, John wants a way to:
- Minimize his risk exposure to market volatility.
- Leverage his legacy to his children.
- Reduce risk associated with economic and tax uncertainty.
IF YOU HAVE A CONCENTRATED POSITION LIKE JOHN-
Here’s what John’s advisor recommends: Liquidate $1 million $3 million – Stock Portfolio
- John sells 24,390 shares of XYZ stock at $41 per share for $1 million. Today he pays a 20% federal capital gains tax, a 3.8% Medicare tax on investment income for federal tax of approximately $145,2391.
- If John waits to sell his large concentrated stock position and President Biden’s proposal on capital gains is enacted into law John could pay a 39.6% tax rate on the gain of approximately $241,658. After paying taxes based on the $15.98 per share cost basis, John uses some of the remaining $854,761 to buy a life insurance policy.
- By selling just a portion of his stock, John reduces his concentrated risk and protects his legacy with a legacy with a death benefit that can pass to his children/family income tax-free.
Terri Getman, J.D.*, CLU, ChFC, RICP, AEP (Distinguished)
Two bills introduced in the Senate in March could significantly change estate planning if enacted into law. The 99.5% Act and the Sensible Taxation and Equity Promotion (STEP) Act would dramatically alter transfer taxes. While it is still uncertain which, if any, provisions in these acts will become law, it is still important to be aware that the bills contain the following provisions:
- Reduces the federal estate tax exemption from $11.7 million to $3.5 million for U.S. citizens and residents.
- Reduces the federal gift exemption from $11.7 million to $1 million for U.S. citizens and residents.
- Taxes unrealized capital gains in non-grantor trusts, including existing trusts, beginning in 2026.
- Ends tax breaks for Dynasty/GST trusts (generation-skipping transfer trust) by imposing tax every 50 years.
- Increases the federal estate and gift tax rate from a top bracket of 40% to a more progressive federal estate and gift tax rate ranging from 45% (for values starting at $3.5 million) up to 65% (for values exceeding $1 billion).
- Includes grantor trusts as part of the grantor’s taxable estate, thereby impacting and potentially eliminating many common estate planning strategies such as ILITs
(Irrevocable Life Insurance Trusts) and IDGTs (Intentionally Defective Grantor Trusts) by including assets in the estate of the grantor.
- Imposes a capital gains tax on built-in gain on property gifted subject to a $100,000-lifetime exclusion and exclusion for transfers to charities, spouses who are U.S. citizens or
long-term residents, and grantor trusts that are included in the grantor’s estate.
- Significantly reduces the ability to discount values for minority/lack of control for non-active, closely held business interests, transferred where a family owns 50% or more in vote or value.
- Reduces the effectiveness of GRATs (grantor retained trusts) by requiring a 10-year minimum period and minimum 25% remainder value, thereby prohibiting the use of “zeroed-out” GRATs.
- Imposes a capital gains tax on built-in gain on the property transferred at death, and subject to a $1 million exclusion and exclusion for transfers to charities and spouses.
Limits annual exclusion gifts to two times the effective amount or $30,000 for transfers to trust or pass-through entities.What does this mean for you?
By Terri Getman, JD, CLU, ChFC, RICP, AEP (Distinguished) and Christopher J. Layeux, MBA, ChFC, CLU
Premium Finance demand is surging and changes to IRC §7702 are an accelerant. On December 27th, 2020, the President signed into law the Consolidated Appropriations Act, 2021 (CAA). The legislation included changes to the interest assumptions used in IRC §7702—the Internal Revenue Code (IRC) provision that defines how much premium can be contributed to a life insurance policy. Specifically, IRC §7702 defines the guidelines that must be satisfied for a policy to be treated as a life insurance contract for federal tax law purposes. To meet the requirements, contracts must satisfy one of two complex actuarial tests, known as the Guideline Premium Test (GPT) and the Cash Value Accumulation Test (CVAT). These tests impose limitations on the amount of premiums paid into a contract and/or the amount of cash value that can accumulate relative to the death benefit. IRC §7702 established assumptions for defining the actuarial values, including the use of minimum interest rates.
The minimum interest rates used in §7702 have not changed since its enactment in 1984. Since the passing of §7702 interest rates have declined and today remain at or near historic low levels. To address this situation the CAA 2021 changed IRC §7702 by replacing the fixed 4% and 6% interest rate assumptions with a dynamic interest rate model effective beginning in 2022, thus allowing the interest rates to float over time in keeping with prevailing market rates. Furthermore, beginning in 2021, CAA permits carriers to lower their interest rate assumptions for product design purposes to 2%. It’s important to note that this change permits carriers to create new products with lower guaranteed interest rates. The legislation does not apply retroactively to existing policies.
The effect of this reduced interest rate approach will be to effectively increase the amount of premium eligible for deposit into new life insurance policies for any given face amount. This limit also serves to create lower minimum death benefit availability for those seeking to pay a specific amount of premium over a predetermined period.
The ability to increase the amount of premium that can be deposited into a life insurance policy will impact a number of life insurance planning strategies. Specifically, financial professionals should reexamine planning strategies such as loan rescue, Life Insurance as a Retirement Plan (LIRP), deferred compensation, Supplemental Employer Retirement Plan (SERP), split dollar and Premium Financing. While all of these concepts will be positively impacted by the legislation, this year may be the best time to reexamine Premium Finance, specifically given the interest rate environment, as a strategy with high net worth clients.
What is Premium Finance
Premium Financing is a planning strategy typically used by high net worth individuals or businesses to purchase needed life insurance coverage using a loan from a commercial bank. As with all advanced planning techniques, it is not for everyone and should be approached with appropriate due diligence. However, a properly designed and managed premium finance design may offer significant benefits.
Four Factors Driving Premium Finance
Demand In addition to the recent change to IRC 7702, there are at least four other reasons why this may be one of the best times for advisors to talk with their high net worth clients about Premium Finance.
First, the cost of borrowed funds is a significant factor when determining if premium finance is a suitable strategy. To have value for a client, the cash flow of a financed design must make economic sense based on loan costs, comparative return on capital, liquidity and the risk of borrowing. Today, clients have access to historically low lending rates for premium finance cases. The current interest rate environment may be attractive to customers seeking to fund needed life insurance with minimal disruption to their existing capital and assets, or to business owners who are able to earn more on their existing capital inside their businesses as opposed to paying premium directly.
Most loan rates are generally based on LIBOR plus a spread and typically are not fixed. Although the yields on 10-year Treasuries have ticked up slightly recently, the Federal Reserve has signaled its intention to keep rates near zero for the near future. This creates a unique opportunity to access the potential elongated differential between shorter and longer term interest rates given current Fed policy. This is particularly true given that policy crediting is more closely tied to Treasury yields in the 7 to 10 year maturity horizon, while commercial lending rates tend to be tied to a shorter maturity funding model. With the prospect of historically low interest rates for an extended period of time, today’s economic environment may represent an excellent opportunity for suitable clients to consider premium financing as a funding solution for their life insurance needs.
Second, COVID-19 has had a significant impact on nearly every aspect of our lives. From non-essential businesses being shut down to the transition to a virtual workforce we have seen meaningful disruptions to the flow of goods and services. Without question, the insurance industry was also significantly impacted. Insurance carriers were uncertain what the mortality impact would be from the pandemic. Some carriers restricted or even postponed underwriting on certain higher risk ages and larger face amounts. New underwriting guidelines were developed in an attempt to work within the pandemic environment. Without the ability to meet with their financial professional and get their coverage underwritten, many clients put their life insurance coverage purchases on hold.
We are now seeing the light at the end of this long tunnel with three effective COVID-19 vaccines, and the insurance carriers are beginning to remove temporary underwriting restrictions. Given these positive developments coupled with significant pent up demand, customers are beginning to move forward with their insurance plans. This pent-up demand skews heavily towards older clients and those seeking larger death benefits, as they were the most directly impacted by the carriers’ pandemic underwriting restrictions. Many of these clients may be suitable for considering premium finance as a funding strategy for their life coverage.
Third, with over 500,000 deaths attributed to COVID-19, the pandemic dramatically raised awareness of the need for life insurance protection. As ownership of individual life insurance coverage has trended downward over the past few decades, the pandemic’s psychological impact has driven an increased demand for life insurance protection.
Fourth and finally, the Biden administration, with the benefit of a Democratically controlled House and Senate, has signaled a desire to enact sweeping change to income and estate taxes. Clients are seeing a constant barrage of news headlines, many having significant financial implications such as a reduction in the amount sheltered from estate/gift tax from $11.7 million to proposals between $3.5 and $5 million. Additionally, high income earners are seeing proposals showing an increase in income tax brackets without relief on the Medicare excise tax passed under the Affordable Care Act. Additionally, the ultra-affluent are seeing headlines about the emergence of a Wealth Tax. These proposals are serving as a catalyst to motivate clients to put their financial and estate plans in order. The prospect of the gift tax exemption being substantially reduced dramatically increases the challenge of funding any needed life insurance owned in an ILIT without triggering gift tax obligations. Premium finance may offer an efficient solution, as generally loans to an ILIT to pay premiums do not trigger a gift tax.
The Fifth Factor Driving Premium Finance Demand: Recent Changes to IRC §7702
The recent change to the regulations under IRC 7702 makes premium finance more attractive for high net worth clients. As previously indicated, one effect of the reduced interest rate change will be to increase the amount of premium that can be deposited—resulting in potentially improved 7-pay MEC premiums relative to death benefit purchased. These modified interest assumptions provide improvement that diminishes with the issue age of the insured. The average age for a typical premium finance insured is approximately 50. As an example, a 50-year old client may see a 50% improvement in their 7-pay premium limit. This additional improvement helps drive down internal Cost of Insurance (COI) charges which, in turn, enhances policy performance. While carriers are just beginning to introduce new products based on the 7702 revisions, the average 50-year-old client may expect to see an improvement of 10 basis points (0.1%) or more in Internal Rate of Return (IRR) at life expectancy, with actual differential impacted by age. This creates an opportunity for enhanced performance, and, properly designed, the client may see an increase in policy values sufficient to better absorb product performance fluctuations.
These new interest rate assumptions don’t come without cost to the financial professional. Because the result is often a smaller death benefit for the same premium, the financial professional will likely see a corresponding reduction in target premium. So, while minimum death benefit designs will become more efficient, a negative impact on compensation is also likely. Additionally, reduced death benefits may no longer meet the client’s insurance goals. Premium financing is one solution that may allow the death benefit to be restored to the desired level and simultaneously improve the client’s out of pocket cashflow. The higher death benefits made economical through premium finance may also restore the target compensation premium for the financial professional.
Finally, the changes to IRC §7702 potentially allow for design simplicity. In the past, most premium finance designs used GPT and an increasing death benefit design that switched to level when the premium payment ended. While the GPT corridor levels are the same with the revised regulations, the corridor levels for the new CVAT are substantially reduced. Consequently, accumulation designs may now consider using a level CVAT approach. A drawback to the old approach is that the policy switch from increasing to level requires the policy owner to make an election, potentially many years in the future. Failure to elect planned changes could have a significantly negative impact on the product’s planned performance. A level death benefit design using CVAT with the narrower corridor may allow for a simpler model that not only meets the client’s objectives but also mitigates risk for the client and the financial professional. Proper case due diligence may require a comparison of the newer CVAT design with a GPT design (financed or not) to determine which model is a better fit for the client’s objectives.
- Premium finance demand is on the rise and the recent changes to IRC §7702 not only create meaningful planning opportunities in Premium Finance but have driven increased demand in the market space.
- Premium finance demand has been driven by 4 key factors including (1) Cost of borrowing and the differential between short and long term interest rates, (2) Pent up demand particularly in older age groups as a result of the COVID-19 pandemic, (3) A change in psychology around the need for life insurance in the post-pandemic mindset, and (4) The emergence of political trending toward increased taxation, particularly in the areas of estate and wealth transfer along with taxes targeting high earners.
- A fifth factor has now emerged, layering incremental demand for Premium Finance—significant changes to IRC §7702. These changes increase the amount of premium eligible for deposit into new life insurance policies for any given face amount. This limit also serves to create lower minimum death benefit availability for those seeking to pay a specific amount of premium over a predetermined period.
- Premium Finance represents a meaningful opportunity for financial professionals focused in the high net worth and/or business owner space, with IRC §7702 changes enhancing the opportunity set.
Interest in life insurance has grown in the last year as a result of COVID-19 as people have realized that they have a clear need for life insurance. In fact, 31% of consumers said they are more likely to buy life insurance because of the pandemic as the 2021 Insurance Barometer Study by LifeHappens and LIMRA shows. It is easier than ever before to obtain coverage with more and more digital processes. Take a look at the new findings here!
2021 presents a unique opportunity for individuals to accomplish significant transfer tax planning. The reasons for this include the following:
- An individual can currently transfer $11.7 million of property without gift, estate, and generation-skipping taxes.
- The current top transfer tax rate is 40%.
- Several strategies utilize interest rates that are at historic lows.
However, the heyday for gifting could be coming to an end this year. A number of legislative proposals would reduce the amount that can be gifted without being subject to tax. This would also limit several transfer planning techniques like short-term GRATs, generation-skipping transfer trusts, and valuation discounts.
Some of your high-net-worth clients with large estates have likely been working with their legal and tax advisors to take advantage of this unprecedented opportunity to make large, tax-free transfers. Many of these clients will still have taxable estates after the transfer – so they continue to have a need for life insurance. While these clients have the assets and the liquidity to pay for the life insurance they need, they could lack enough annual exclusion gifts and/or gift tax exemptions to get the premium into an Irrevocable Life Insurance Trust (ILIT) without having to pay gift taxes. And while money is no object when it benefits their heirs, benefiting the government is another story. How can you help your wealthy clients fund their ILITs without incurring gift taxes? The chart below summarizes some of the options available to fund a large life insurance need.
Situation: The uncertainty of the estate tax laws has created a dilemma for many taxpayers, estate planners, and insurance professionals. Should moderately high net worth couples take action today to shelter a significant amount from estate tax (under the $11.7 million exemption) by making a large gift; or should they hold off making a large gift and hope that the value of their estate stays under what is likely to be a much smaller exemption in the future?
One of the most obvious examples of this dilemma is found with the traditional irrevocable life insurance trust (“ILIT”), which has played a critical role in estate planning for many years. If an ILIT is established, access is significantly limited. On the other hand, if a decision is made to wait to establish an ILIT, the proposed insured’s health could deteriorate, thus significantly increasing the cost of insurance coverage. Even worse, the individual may become uninsurable and insurance may be unavailable especially in this COVID environment.
The Standby Trust (also referred to as the Wait-and-See Trust) was developed as an alternative to the ILIT because it permits the insureds (i) to purchase survivorship life insurance today based upon current underwriting conditions and (ii) to retain a great deal of flexibility. This Counselor’s Corner provides information about this arrangement.
Solution: In general terms, the Standby Trust arrangement utilizes an ownership and beneficiary structure on a survivorship policy on the lives of a married couple. The insured with the shorter life expectancy is named the initial owner of the life insurance policy (“the insured owner”) and premium payer. At the time the insurance is purchased, a trust (i.e., the Standby Trust) is also established as either an existing stand-alone (revocable or irrevocable) trust or as a testamentary trust and is named the contingent owner and primary beneficiary. If the estate tax continues to not apply to the client’s situation, the Standby Trust may not be utilized. On the other hand, if the estate tax does apply, then the life insurance policy can be transferred to the Standby Trust in an attempt to minimize future estate tax consequences.
Under this arrangement, trust ownership of the policy is normally deferred until after the death of the first insured, thus giving the insureds the time needed to make any irrevocable decisions concerning the ultimate policy ownership. Consequently, during the lifetime of both insureds, this arrangement provides the insured owner of the policy with (i) a great deal of flexibility, (ii) easy access to cash values for retirement and other uses, and (iii) the potential to exclude the net death benefit from the estate of both insureds. It is important to note, however, that there is a price associated with all of the flexibility. In a Standby Trust arrangement, since the insured owner initially owns the policy, the entire cash value will be included in his/her taxable estate if he/she is the first to die. The application of the so-called “three-year rule” of IRC Section 2035 is also a possibility.
 Since this technique does not require ownership of the survivorship policy by the Standby Trust from the inception, it is not necessary to have the Standby Trust in existence at the time of policy application. However, it is prudent to have the trust established as soon as possible.
The industry is constantly evolving, and we continue to see change in many areas that affect the work you do with your clients. The good news? With all of this change comes opportunity. Terri Getman, DBS Business Development Director, has laid out three big opportunities to take advantage of NOW. She’s also identified which of your clients to approach to take advantage of the opportunity. Reach out to Terri at 800.869.1327, extension 230 with your advanced case questions today!
Life Insurance as a Retirement Supplement
- Why Now?
- Prospect of higher income taxes for incomes over $400k
- Potential loss of deduction for qualified plans. Replaced by 26% flat credit
- Recent 7702 legislation, making accumulation focused policies more efficient
- Client Profile:
- Executives, professionals, highly compensated business proprietors
- Usually, ages 40-55
- Maxed out qualified plan contributions
- Healthy clients with a need for life insurance or interest in long-term care/chronic care benefits
Life Insurance to Cover IRD Tax
- Why Now?
- SECURE (December 2019) & Proposed SECURE 2.0
• Delayed start date for Required Minimum Distributions
• Eliminated stretch distribution for most beneficiaries replaced with 10-Year distribution
• Increased income (IRD) taxes for beneficiaries
- SECURE (December 2019) & Proposed SECURE 2.0
- Client Profile:
- Clients with “significant” qualified plan balances
- Usually, ages 60-75
- Those desiring to control distribution from the grave
- Possible desire to provide flexibility to heirs
- Healthy clients – especially if they are also subject to state or federal “death” tax
Gift of Life Insurance to pay Death Taxes
- Why Now?
- High exemption of $11.7M ($23.4M/couple) will sunset in the near future reducing to $5+M (2026
- Low interest rate environment makes many estate techniques attractive
- Possible elimination of many popular estate strategies & possible elimination of basis step-up
- Large gifts today grandfathered – no clawback of gift amount exceeding exemption at date of death
- High exemption of $11.7M ($23.4M/couple) will sunset in the near future reducing to $5+M (2026
- Client Profile:
- Single clients with net worth greater than $5M or married with net worth over $10M
- Usually, ages 60-75
- Clients living in one of the 17 states or DC who are subject to state-level death tax with net worth larger than state exemption
- Younger clients with appreciating assets
Most can agree that 2020 was an unprecedented year, bringing change to nearly all aspects of life. It was certainly felt by the DBS Case Design Team with more change than ever in the form of new products, reprices, illustrated rate changes, and regulation compliance. This was even after losing a number of products as carriers phased them out to comply with the PBR/2017 CSO mortality table deadlines at the end of 2019. Persistent Low-Interest Rate Environment: Though the focus early in the year was on the aftermath of PBR/CSO, we quickly shifted gears when interest rates dropped to 0.25% in March. After this announcement, we saw pricing hikes to no-lapse guaranteed products and lower caps on indexed accounts. COVID 19: The pandemic also hit in March, and we saw carriers make temporary (and sometimes permanent) changes such as enacting age restrictions, premium limitations, table limits, and other changes.
AG 49-A: Life insurance carriers only had a few short months to comply with this deadline, and the responses were varied with some carriers making substantial changes to their products, while others were basically unchanged except for illustrative restrictions imposed by AG 49-A.
Section 7702: In addition, the industry is now reacting to the newly released changes to section 7702 of the tax code dealing with life insurance. Transition rules are not yet clear, but there will no doubt be more changes to come.
What does the future hold?
Your DBS Case Design Analysts are your product specialists, following carrier changes very closely. And, we still have access to the most competitive products available, so you can count on us to help guide you to the best solution for your clients.