Asset protection and estate planning Featured

12:33pm EDT October 29, 2006
Five years ago, Congress passed reform legislation that many hoped would bring certainty to the estate tax. Unfortunately, there is even more uncertainty because, as written, the new law expires and returns to the law as it existed in 2001. This has left many to speculate on just what Congress is going to do, prompting heated discussions about whether or not the estate tax will be repealed altogether.

As a result of this uncertainty, many people who purchased life insurance policies as a means to pay their estate taxes are left wondering if they should continue paying premiums if there’s a chance the estate tax may be repealed, says Scott Borsack a partner in the Tax, Trust and Estates Practice Ggroup at White and Williams LLP.

“Regardless of what happens to the federal estate tax, people should not cancel life insurance policies just because they think the estate tax will be repealed,” he says. “Besides the uncertainty of whether of not the tax will actually be repealed, there are plenty of reasons to keep those policies in force.”

Smart Business spoke with Borsack about the reasons for obtaining life insurance and how the estate tax discussions affect life insurance policies.

Why should executives obtain life insurance?
Life insurance allows those who survive the insured to continue to live in the manner to which they have become accustomed. In cases where an estate tax may be owed upon the death of the insured, life insurance allows the survivors to pay the tax liability in a timely manner. But the most often overlooked aspect of life insurance is its use in sound financial planning. The cash value — which grows tax free in a life insurance policy — can also be accessed tax-free through a policy loan that does not have to be paid back until the death of the insured.

How much life insurance do most executives need?
Financial advisers have complex formulas that consider a number of factors, including age, savings, earning capacity and future needs, including college tuition and mortgage payments. My own rule of thumb is that a family of four with minimal debt and living an average lifestyle should have a minimum of $1 million in insurance coverage on the life of the primary wage earner.

What are the prospects for reform to the current federal estate tax?
Over the last five years, a number of attempts have failed to permanently repeal the estate tax, as well as the most recent attempt to permanently exempt $5 million for each taxpayer from the federal estate tax. However, we probably won’t see estate tax reform come back until after this year’s election. Having said all that, the prospects for further change are pretty good, but we just don’t know exactly what those changes are going to be.

What are the risks of canceling an active life insurance policy?
In the midst of all the discussion of changes to the estate tax, many people are wondering why they should continue paying their premiums if the tax is going to be substantially changed. But people should think very carefully before letting an active policy lapse. Many people take out a life insurance policy when they are healthy at substantially reduced premiums. However, over time, health may change and that perfectly good policy, which the insured allowed to lapse, may not be replaceable, or if it can be repurchased, the new premiums may be prohibitively expensive.

Even those who purchased life insurance solely as a means to pay for their estate tax should consider maintaining that policy, regardless of inevitable changes to the tax law, until they know for sure just what those changes are going to be.

How does the estate tax affect the way life insurance policies are owned?
One thing that is often overlooked is how the life insurance policy should be owned. Everyone assumes that death benefits paid under the insurance policy will not be subject to the estate tax; however, that’s only true if the beneficiary is the surviving spouse. But what happens if both parents die together, or there is no surviving spouse? I generally recommend that insurance policies with a death benefit in excess of $1 million be put into a life insurance trust that protects the death benefit from the estate tax and allows premium payments to be made gift tax-free.

SCOTT P. BORSACK is a partner in the Tax, Trust and Estates Practice Group of the Business Department at White and Williams LLP. Reach him at (215) 864-7048 or borsacks@whiteandwilliams.com.