Recent passage of The Tax Cuts and Jobs Act of 2017 (TCJA) increased the federal unified estate and gift tax basic exclusion amount from $5.49 million in 2017 to $11.4 million per individual and $22.8 million per married couple for 2019.
While this change has been celebrated in many quarters, it has created for clients a false sense of security. The higher exclusion will sunset and revert to $5 million (adjusted for inflation) after December 31, 2025, absent future legislation. The probability is growing more likely Congress will allow the doubled lifetime exemption to sunset, as polls show growing bipartisan support for higher taxes on wealthy individuals.
You Snooze, You Lose
We believe clients who choose to “wait and see” what happens to the Estate/Gift tax laws until the sunset occurs could be sabotaging their overall estate plan, especially when a hedge is already available. Between now and 2026, they could lose their ability to obtain life insurance, be unable to get a favorable carrier rating due to a new medical condition or be subject to higher estate tax rates prior to 2026, depending on how future elections turn out. In short: if you snooze, you may lose.
The ‘Wait and See’ ILIT
The “Wait and See” Irrevocable Life Insurance Trust (ILIT) is a creative and IRS approved strategy that can address multiple wealth planning objectives, including retirement, estate and asset protection planning. The strategy can be used to supplement a client’s retirement income while also creating a legacy for their loved ones in a tax-advantageous and asset-protected manner.
The ‘Wait and See’ ILIT Strategy at a Glance
- Client creates ILIT to purchase and own a cash-value life insurance policy
- ILIT considered a “grantor trust” for federal income tax purposes
- Client lends cash to the ILIT in exchange for an interest-bearing note
- ILIT trustee uses the cash lent to pay the life insurance premiums
- During the client’s retirement, the trustee accesses the cash value of the life insurance policy through loans or surrenders to make payments on the promissory note, thereby supplementing the client’s retirement with an income-tax free cash flow
The client’s death leaves an income- and estate tax-free legacy in the form of the life insurance policy’s death benefit, minus any amount remaining on the promissory note. This legacy can be protected from creditors of the trust’s beneficiaries if the ILIT is properly structured.
Why is the note repayment tax-free?
Because the trust established by the client is a Grantor Trust, the IRS views the repayment of the loan from the trust to the client as if the grantor were repaying himself. Therefore, the principal and interest portion of the loan repayment is income-tax free.
Why is the death benefit not included
in the insured’s estate?
Since the trust is both irrevocable and properly structured, upon death the assets held inside the trust are not includable in the estate of the insured/grantor. If the insured/grantor dies before the note is repaid, only the outstanding note balance is included in the grantor’s estate.
Supplement Client Retirements and Help them Leave a Legacy
While the main purpose of life insurance is providing death benefit protection, the primary dual objectives of the ‘Wait and See’ ILIT are supplementing retirement income and creating an enduring legacy.
The ‘Wait and See’ ILIT solution will help your clients reposition some of their liquid assets into a structure that can help reduce both their income and estate tax liabilities. This solution can be customized to meet various client objectives and may be appropriate for a wide range of client profiles.
To find out more about how this strategy can help your clients, email AdvancedPlanning@highland.com.