The 2001 tax law reduces the likely impact of future estate taxes. The per-person exemption moves up to $1 million in 2002, with a further increase to $1.5 million scheduled for deaths occurring in 2004. By 2009, that effective exemption amount will be $3.5 million. Barring additional legislation, the federal estate tax is scheduled to disappear in 2010 and reappear in 2011, with a $1 million exemption. Many people are paying sizable premiums every year for life insurance policies that will provide the cash to pay estate tax. However, such policies might no longer be needed for estate tax purposes, given the large exemptions. Some experts say that it is likely the increases in the exemption will remain, even if the estate tax is not entirely repealed.
If the estate tax stays in place, with the higher exemption levels, as many people expect, people with estates in the $1 million to $3.5 million range ($2 million to $7 million for married clients) might not face estate tax. Thus, people who are only marginally in estate tax situations may not need their insurance any longer. Some financial planners say that people with estates under $5 million should think about winding down insurance policies bought primarily to pay estate taxes. This “winding down” might be done apace with the tax law. That is, a married couple might plan on being able to shelter up to $2 million worth of assets in 2002 and 2003. If their estate is larger, life insurance may be needed to pay the estate tax bill. In 2004 (assuming no further changes in the interim), the amount that this couple can pass on, tax-free, goes up to $3 million, and insurance might be adjusted accordingly. Similar moves could be taken in the future, as the estate exemption increases.
In some cases, therefore, insurance policies already in place might be deemed unnecessary. If so, what can be done with those existing policies? One option is to enter into a so-called “Section 1035” exchange, tax-free, for a deferred annuity. Then you can either stop paying the premiums or pay a smaller amount. The new contract eventually might be annuitized, providing a partially tax-sheltered stream of income.
Another option is to simply surrender the policy. However, the cash you receive for the policy may be reduced by income taxes and surrender charges. Ask a professional advisor about the consequences before surrendering or exchanging a life insurance policy.
(For those who hold fast to the insurance/estate relationship, see item below: “Unsure About Insurance.”)
