Prepare for changes with effective solutions
If change brings opportunity, we may be entering a world where opportunity lies around every corner. While we currently don’t know what tax provisions will be passed into law, we do know that the earlier we begin planning, the more prepared we can be.
In early September, the powerful House Ways and Means Committee released a proposal with the intent of funding President Biden’s ambitious agenda. The proposal includes changes to our current tax system in multiple ways, including:
- The corporate tax rate moving from 21% to 26.5%
- The top capital gains rate moving from 20% to 25%
- Removal of Roth conversion for some
- Impacts to large IRA balances
Let’s look at the proposed changes to the top income tax rate, the lifetime exemption and grantor trusts.
Change: The proposal would increase the highest income tax rate to 39.6% from the current 37% while reducing the income threshold to get there to $400,000 for single filers and $450,000 for married filers.
Consider: Permanent life insurance offers tax-deferred growth of cash value and distributions on a tax-advantaged basis when a policy is structured properly. For high-income earners, this may be an opportunity to use cash value from life insurance in retirement to lower the total rate paid on all their cash flow. A source of funding may be to reallocate dollars they are already saving. A variable universal life policy offers access to subaccounts that offer familiar names to those participating in IRA or 401(k) plans.
Change: A question we seem to get the most revolves around what will happen to the exemption. The House Ways and Means proposal effectively eliminates the Tax Cuts and Jobs Act with respect to the exemption by accelerating the originally planned sunset. In the proposal, the date moves up four years from December 31, 2025, to December 31, 2021. This means the exemption would move from $11.7 million for individuals to roughly $6 million. We may truly be in a “use it or lose it” scenario.
Consider: Can you lock in the $11.7M? Technically, no. However, life insurance offers an option for those concerned, but not able to make a maximum gift. Rather than gift too much and be uncomfortable — or do nothing — perhaps make a smaller gift that guarantees the heirs get the current applicable exemption. For example, a male age 60 with preferred underwriting could make a gift of $4M to a trust that buys $11.7M of variable universal life insurance, guaranteed for life. This gives $11.7M of liquidity at death, which is not includable in the estate and doing so at a discounted amount when comparing premium paid to the death benefit.
Change: Grantor trusts, long used in estate planning, face major changes and challenges. The first is that assets held in a grantor trust would be included in the decedent’s taxable estate when the decedent is the deemed owner of the trust (the grantor). In addition, sales between a grantor trust and its deemed owner (the grantor) would be treated as sales between the owner and a third party. These provisions would be applicable for trusts created after the date of enactment and to any portion of a preexisting trust attributable to a contribution made after the date of enactment.
Consider: The first step to avoid this is recognizing that new grantor trusts must be created and funded before the enactment date, which is subject to change. Contributions to existing grantor trusts after the effective date of the provision will cause that portion of the trust to be impacted by the new rule, and possibly lose grandfathering under the current rules. It is suggested that an existing grantor trust could still purchase assets from the grantor (at fair market value) until enactment date.
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Lincoln is here to help support you as you address client concerns and make changes to align their financial goals with the current environment.
Connect with your Lincoln Life Wholesaler or call us at 866-247-1604.
About the author
Tim O'Connell manages Lincoln’s Advanced Sales team that supports all life insurance products. He previously worked as both a national internal and external wholesaler helping agents and financial professionals with multiple products and product lines. Prior to that, he was a financial professional specializing in comprehensive financial planning and his office was voted number one in sales for five consecutive years.
He holds a FINRA Series 6, 63 and Connecticut life, accident and health license, and resides in Connecticut.