Tier One: Life Insurance Needs Created by President Biden
There is no doubt about it - COVID-19 has exploded the federal budget. In 2020, in addition to ‘regular’ spending, the Committee for a Responsible Federal Budget estimates the government has spent $5.22 trillion in COVID-19-related funding to date, with additional Coronavirus-related stimulus coming from the lame duck Congress or shortly after President-elect Biden is inaugurated. This comes after four years of increased spending without a related increase in federal revenues under the Trump administration. The US government's Bureau of Economic Analysis for 2019 reported $7.3 trillion in total government expenditure and $21.4 trillion total GDP - which makes spending 34% of GDP (with a deficit equal to 17.9% of GDP).
What this means is that while the Congressional Budget Office stated this summer that it is likely the U.S. economy will not recover to pre-COVID-19 levels until 2028, the level of recent spending could change the calculus to where economic recovery takes decades.
The easiest tool a Democratic Administration has to address the deficit is to raise taxes. Whether or not raising taxes is possible with a potentially divided Congress is an open question, but now is the time to examine President-elect Biden’s announced tax proposals and focus attention on the need for professional life insurance planning to address these potential changes.
Here are a number of the most significant of President-elect Biden’s tax proposals as published by the Tax Foundation, the nation’s leading independent tax policy research organization. Each creates a need for life insurance.
Restore the estate and gift tax rates and exemptions to 2009 levels.
Currently, the top estate tax rate is 40% on amounts over $1 million. The 2021 estate tax exemption amount will be $11.7 million per person and the annual gift tax exemption will remain at $15,000. President-elect Biden has proposed a 45% top estate tax rate and to move to lower the estate tax exemption to $3.5 million per person, lower than the approximately $5 million sunset rate already set to occur at the end of 2025. The annual gift tax exemption would be lowered to $13,000.
This means it will become exceedingly difficult for affluent individuals and families to move wealth out of their estate. The more wealth subject to a higher estate tax, the greater the need to consider life insurance in an irrevocable trust to offset those taxes and replace wealth to heirs.
Reverts the top individual income tax rate for taxable incomes above $400,000 from 37% to 39.6% and caps the tax benefit of itemized deductions to 28% of value for those earning more than $400,000. In addition, there would be a 12.4% Social Security payroll tax for wages above $400,000, split evenly between the employer and employee.
The more money paid to taxes, the less there is to save for the future. Qualified plans limit the amount high earners can save but those limits do not exist with Life Insurance Retirement Plans (LIRPs). Using a LIRP, a participant can grow money tax-deferred and access the funds tax-free in the future. In addition, LIRPS can have fixed or variable rates of return and allow for participation in the market. Learn more about LIRPs here.
Increases the corporate tax rate from 21% to 28%.
One potential impact is that businesses may decide to channel spending away from employee benefits. In order to incentivize, retain, reward and retire employees, companies can turn to nonqualified plans informally funded by life insurance. Whether the plan design involves traditional deferred compensation, supplemental employee retirement plans (SERPs), executive benefit plans, or split-dollar, life insurance permits the employer to recoup expenditures, including the time value of money, while having a meaningful impact for both the employer and employee.
Tax-exempt investors will see unrelated business taxable income (UBTI) increase from 21% to 28% as will foreign investors into U.S. real estate who will see the same increase in Foreign Investment in Real Property Tax Act (FIRPTA) taxation.
By making investments through a private placement variable annuity (PPVA), both tax-exempt investors and foreign investors into U.S. real estate can eliminate UBTI and FIRPTA taxation. While considerably more tax-efficient than using leverage and far less costly and administratively burdensome than making investments through an offshore blocking corporation, a PPVA is an inexpensive and flexible alternative for these institutional investors.
One tax proposal which is not addressed by the Tax Foundation but that has been rumored during the campaign is moving the capital gains rate to equal the ordinary rate of 39.6%. Then, the Net Investment Income Tax (NIIT) of 3.8% would be added for a total tax of 43.4%.
This increase to investment taxation can potentially be mitigated by the use of private placement life insurance (PPLI). Using PPLI, an investor can recharacterize highly tax-inefficient investments as life insurance by combining an insurance structure or chassis with investments in the form of separate accounts or insurance dedicated funds. By doing so, the investment receives the tax benefits of life insurance: tax-deferred growth, tax-free policy loans and the ability to pass investments as a part of the income tax-free death benefit.
As HNW individuals and families revise their post-election tax planning, the team at Life Insurance Strategies Group is ready to help structure the appropriate life insurance solution. LISG does not sells products and only offers independent and unbiased advice to those seeking help with their life insurance needs.
About the Author
Peter T. Dziedzic, Jr., is the General Counsel & Chief Operating Officer for Life Insurance Strategies Group, an independent consultancy providing experienced advice to HNW individuals and families regarding their life insurance needs. Pete is a graduate of Yale University and the University of Virginia School of Law.
View our YouTube video on this topic by clicking here.
Read our companion Tier One Interview with Kari Gillenwater by clicking here.
Since its inception, Life Insurance Strategies Group has solely focused on the individual high net worth life insurance market. We do not sell products. This allows us to offer unbiased, pragmatic advice. Visit us at www.lifeinsurancestrategiesgroup.com.