By Thomas J. Archer, CFP
The estate tax cuts in the new Tax Reform Bill, which was passed in both the House and Senate last week, could help foster continuous future investing among a person’s heirs and will help ensure that real estate and businesses remain in the family. This is because the new tax bill will allow the exemption for estate taxes to increase from the current limit of $5 million to approximately $11 million. Those with families can double their maximum exemption from $10 million to over $22 million.
This, coupled with life insurance death claim payouts, will lighten the financial burden for high-net-worth individuals who wish to pass on their assets to their children. It will ensure that assets remain in the family after the person has passed on. It also frees up finances—whether it is from what they earned or inherited—to be turned into future investments in real property, businesses, stocks or bonds.
Those in support of the bill were initially aiming for a total elimination of the federal estate tax, but the revised structure was the result of negotiations. The way the estate tax stands now, an individual’s estate is typically double-taxed, before and after the earner’s death. As a result, heirs are forced to sell off family-owned properties and businesses to pay the tax, resulting in devaluation and further depletion of the estate. Those who had to sell off their assets argue that this multi-taxing is unfair and that the repeal is essential to ensuring that future generations will be able to sustain a family’s financial position.
I continually advise my clients, who are high-net-worth individuals, that they purchase large life insurance policies to pay the estate taxes. And, this suggestion will continue to remain in effect for ultra-high-net-worth individuals, such as professional athletes and celebrities.
Keep in mind that, under the latest bill, the new taxable threshold is guaranteed only until 2025, when it will be reset to the current $5 million threshold for individuals ($10 million for families) and indexed for inflation. For families whose net worth is below the new threshold, they may not need to worry as much about having the funds available to pay the inheritance tax on a family property, such as a business or a vacation home. But, this could all change again in seven years. Here’s why:
Today, if your family has a net worth of $100 million, each parent gets to exempt the first $11 million in assets from their estate taxes for a total of $22 million. The approximately remaining $80 million is subject to the federal and state tax rate of approximately 40 percent, leaving a $30 to $40 million tax bill to their children. To preserve their assets for their children, the family will purchase a $30 to $40 million second to die life insurance policy.
How does this work out? The family only pays the premium for the policy, which is substantially less than the death benefit. When they pass on, a special trust for the benefit of the children will receive a check from the insurance company. That ultimately is used to pay the federal estate tax. Not a penny of the inheritance will be touched if properly structured.
More than 3,000 high-net-worth families nationwide are expected to benefit from this repeal in 2018 alone and the overall financial benefits will likely be seen in the near future. However, I foresee that there will be a continued demand for life insurance products, largely due to the fact that $22 million is still a relatively low threshold for many of my clients. And, in many states, the beneficiaries will still need to pay a significant amount to cover local estate taxes.
In New York State, where I have two offices and where my family currently resides, there is a 16 percent estate tax rate on the largest estates. Although these exclusions were changed in 2014 to gradually increase from just over $2 million to the federal government’s current $5 million threshold by 2019, an estate worth even just $6 million today would result in nearly $100,000 to be paid out in estate taxes. For an estate worth $100 million, the taxable figure would amount to nearly $16 million.
As most of my clients pay taxes in states with high estate taxes, such as New York and California, I suspect that I will continue to write policies that are intended to cover an heir’s estate tax obligations.
Thomas J. Archer, CFP is CEO of The Archer Financial Group. He specializes in writing insurance policies for high-net-worth individuals for wealth preservation purposes.
