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Life Insurance
Locking the Treasure Chest Becomes More Popular Amid COVID-19, Tax Changes

The pandemic and a looming lowering of the estate-tax exemption, paired with potentially further reductions and increases discussed in Washington, D.C., have cast a light on the role of irrevocable trusts as part of a life insurance and estate plan.
  • Terrence Dopp
  • October 2021
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Key Points

  • Environment: The pandemic forced people to ponder their own mortality as the estate-tax exemption is set to go down by almost half.
  • Unknown: President Joe Biden and others in Washington, D.C., have discussed raising the tax and further lowering the exemption, creating an unknown environment that has made conditions right for finding vehicles to minimize or even remove estate tax burdens.
  • Trusts: Attorneys say they’ve seen a greater willingness to go with irrevocable trusts, which circumvent taxes but also require those establishing them to give up varying levels of control over assets.

Russell B. Long, the deceased U.S. Senate titan from Louisiana, generally gets credit for the old saw summing up Americans' sentiments toward taxation: “Don't tax you. Don't tax me. Tax the guy behind the tree.”

Yet behind the seemingly jokey expression lies a truth: Nobody likes paying taxes, and people will do what they can to head off the taxman—within reason.

Prompted by a confluence of factors including a concern that President Joe Biden and Democrats in Congress will lower the estate-tax exemption, the wealthiest Americans—those able to bequeath sums in the eight-digit range—are finding new appetite for structures such as irrevocable life insurance trusts and other arrangements involving insurance policies to decouple estates, and large death benefits, from that calculation.

Related: COVID-19 a Year Later: Life Insurers Forced Into Digital, Operations Growth in Survival Bid

Shelton Swafford Chambers sums it up this way:

Every three to six years, she urges clients to revisit estate plans as situations and tax law can change. Typically, when she calls one family of nine periodically to say it's time to revisit or make changes to an existing plan, two members are ready and willing to do that. Recently, she said her latest call to the family resulted in six members champing at the bit to do so.

“Absolutely, positively yes,” Swafford Chambers, who practices with Chambliss, Bahner & Stophel P.C. in Chattanooga, Tennessee, said when asked if business was above traditional levels. “Even before Biden was elected there was still a little more interest than usual. Then it kind of accelerated.”

Swafford Chambers prepares dynasty trusts and estate plans for a client roster clustered around manufacturing and transportation business owners. She said the trusts she prepares often go beyond stock ILITs and are so-called defective grantor trusts that include life insurance as a component while encompassing more liquid assets.

The rationale behind the “garden variety” ILIT is simple, according to James G. Pressly, an attorney with Pressly, Pressly, Randolph & Pressly in the well-to-do enclave of Palm Beach, Florida.

If a person goes to their insurance broker and buys a life policy with a $10 million death benefit, down the road that money will be taxed as part of the payout. However, if the same person goes first to a lawyer and establishes a trust to buy the same policy and funds a theoretical premium payment of $1 million through a gift to the trust, then no estate tax is levied on the death benefit, he said.

“Just in general, the more money that you can stow away that will not be taxed at death the better,” he said. “A life insurance trust can be a simple way to do that.”

Shelton Swafford Chambers, Chambliss, Bahner & Stophel P.C.

I think that a global pandemic really had a lot of people thinking about updating their estate plan. So when you combine peoples’ thoughts on their own mortality with this exemption reduction, it did kind of create the perfect storm.

Shelton Swafford Chambers
Chambliss, Bahner & Stophel P.C.

Dropping Floor

Under U.S. tax law, the first $11.7 million of taxable estates are currently exempt from levies for individuals and double that for married couples. Beyond that threshold, the levy can range as high as 40% and in the case of a handful of states up to a maximum of 20% at the lower level. The 2017 tax overhaul led by former President Donald Trump called for the exemption to automatically revert in 2026 to $5.49 million, which with inflation is likely to be around $6 million.

For those with the need, and wherewithal, to see this tax as a real prospect in their estate plans, that alone was enough to prime the pump for greater planning.

Alas, as usual in the last couple of years, there's always more.

First, the COVID-19 pandemic caused many to evaluate their own mortality in a way they hadn't before. And as part of a nebulous and unwritten American Families Plan, Biden has hinted at raising billions in part by targeting the largest estates. In September, Democrats on the House Ways and Means Committee released an initial outline of what they'll seek and the proposal, which could change drastically or go away entirely without approval, calls for a number of changes to estate trust structures and higher capital gains levies. In the Senate, Democrat Joe Manchin has signaled the price tag is too high.

With the certainty that the exemption is cut come 2026—and concern that Congress could go even deeper in the latest round of spending talks—the potential number of people looking at the possibility of heirs facing an estate tax grows. Simply put, it's gone from a problem facing the megawealthy to potentially the workaday wealthy.

“I think there is absolutely concern that it is going to happen earlier,” Swafford Chambers said. “We had a frenzy at the end of 2020 to get as much done as we could. When we first started in 2021 it did die down a little bit because everyone thought when is it going to change and what is it going to be?”

“There's no clear sense of what's going to happen,” she said.

David B. Bingham Mitchell, Williams, Selig, Gates & Woodyard, P.L.L.C.

I’m a tax attorney and I’ve never had a client come in and tell me ‘My taxes are going up or they could theoretically go up and I’m really pleased about that.’

David B. Bingham
Mitchell, Williams, Selig, Gates & Woodyard, P.L.L.C.

Murky Outlook

Clouding the matter is the procedural effort being used in Washington, D.C., to pass the credits.

The Senate chamber is split 50-50 and Vice President Kamala Harris, a Democrat, has the tie-breaking vote to give her party an effective one-vote edge. To skirt Republicans in the Senate, Democrats plan to use the reconciliation process allowing them to approve it along partisan lines.

The bill is essentially blank and the process leaves it up to committees to write it as they go along, meaning the final outcome is hazy at best.

Related: An Old and a New Problem

David B. Bingham, a tax and estate planning attorney with Mitchell, Williams, Selig, Gates & Woodyard, P.L.L.C. in Little Rock, Arkansas, said client awareness of the potential changes varies. Some people will send him articles with the latest developments and others are unaware of potential changes. In normal times he'd prepare one to one-and-a-half trusts per week. Currently, he said not a week goes by that he's not preparing multiple such plans as his clients make deeply personal decisions about taxation and inheritance.

In the current tax environment he divides the world of estate planning into three baskets: those with less than $10 million; those with estates ranging from $11 million to $22 million; and those with more than $22 million. Most of those in the first basket aren't facing any tax threats and the people in the third group know they'll be facing the levies so it's an easy topic to broach. It's the people in the middle who are facing the growing risk and for whom the creation of certain types of trusts is a growing issue, Bingham said.

“I'm a tax attorney and I've never had a client come in and tell me 'My taxes are going up or they could theoretically go up and I'm really pleased about that,'” he said. “Really, it's much more personal.”

Like Swafford Chambers, he said the plans he prepares usually stretch beyond traditional ILITs. That structure can serve as a basis or starting point but often either leave clients with the issue of how to make premium payments on a jumbo life insurance policy without using gift-tax exemption or require the loss of control some find difficult.

Common formats right now include Spousal Lifetime Access Trusts, which allow spouses to retain control over the assets in the trust, and Intentionally Defective Grantor Trusts, which let the grantor place assets into them and removes them from estate taxes while they remain subject in some cases to income taxes.

Both ILITs and other forms of irrevocable trusts can contain so-called Crummey provisions, which allow the grantor to make annual gifts of as much as $15,000 per designee into them while restricting the use of those assets. In both ILITs and more exotic structures, those gifts can be used to make life insurance payments.

David Riedel, an attorney with Adler Pollock & Sheehan P.C. in Providence, Rhode Island, said lower tax thresholds make a pure ILIT more attractive as death benefits come in line with the limit, allowing grantors to use the structure to replace any assets lost to the taxman. Still, he said forming trusts and including life insurance has become more attractive because policies can be tailored to cover the anticipated tax burden, and “eight million” different schemes allow people flexibility to ensure they fit their goals. “The thing now is that the client needs to be willing to pull the trigger,” he said. “What makes it different is the unknown, the various things that have been talked about.”

Swafford Chambers said no one reason has been behind the increased interest she sees. “I think that a global pandemic really had a lot of people thinking about updating their estate plan. So when you combine peoples' thoughts on their own mortality with this exemption reduction, it did kind of create the perfect storm.”


Terrence Dopp is a senior associate editor. He can be reached at terry.dopp@ambest.com.


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