How Do The Changes Affect You?

The 2017 Tax Cuts and Jobs Act had many Americans envisioning more money in their paychecks and companies anticipating huge tax savings. While it does affect several sectors of the U.S. economy, the impact on individuals and families will be clearer at tax time. However, when reviewing your financial status now or early in 2019, the effect on your life insurance also should be reviewed with the future of the tax act in mind – and the fact that many of the individual tax changes are temporary.

The federal tax legislation helped businesses far more than individuals. The business tax cuts are permanent (at least until another major tax bill is passed), but the individual cuts are temporary. They will expire in 2025.

Effect On Life Insurance

Life insurance is often used as an estate protection and tax reduction vehicle. However, the Tax Cuts and Jobs Act could affect that. From a fundamental financial planning standpoint, some people may think the changes reduced their need for life insurance.

However, you need to consider, no matter who wins the 2020 election, if Congress will extend the changes or introduce new ones. What changes affect life insurance? The Tax Cuts and Jobs Act had four provisions that influence life insurance planning: increased amounts excluded from the lifetime gift tax, reduced maximum tax rate for corporations, new rules affecting life settlements, and new rules regarding insurance company reserves and deductions.

Here is more on each item and their effects on insurance policies:

  • The lifetime gift tax exclusion increase – The tax act doubled the gift and estate tax exemption from $5 million to $11.2 million per individual (adjusted annually for inflation). This exempts nearly everybody from the estate tax (only 0.2 percent of all estates are larger and would still be subject to federal taxes). Many people use life insurance to create liquidity and enable heirs to pay estate taxes. With a considerably higher exemption amount, some people who now have life insurance policies may think that they no longer need their life policies as part of their estate plan because they are no longer subject to the estate tax – for now. If the money or assets are transferred after 2025, the need could return, and the person may not qualify for life insurance. At a minimum, it is worth reviewing the policies and needs. Because the exemption increase is temporary, some might decide to keep their policy in effect (which will ensure their heirs receive the proceeds in the future). Also, keep in mind, there is a possibility that the heightened estate exemptions could go down sooner based on actions by Congress and the White House. Additionally, the measure only affects federal estate taxes and several states also have seperate estate taxes.
  • The maximum corporate tax rate drops to 21 percent – Prior to enactment of the 2017 Tax Cuts and Jobs Act, corporations were subject to graduated tax rates that ranged from 15 percent to 35 percent, depending on their taxable income. Now, the corporate rate is a flat 21 percent across all taxable income levels. It also removed the corporate alternative minimum tax completely. These provisions were established primarily for publicly held, larger firms operating as C corporations, which had typically experienced higher overall tax rates and the possibility of being taxed twice, as individual shareholders for dividends paid to them by the corporation, and at the corporate level. This obviously benefits insurance companies but should also lead smaller corporations to use the tax savings to review their insurance coverages, including key-person or buy-sell insurance agreements to protect their futures.
  • New rules for life settlements or selling policies on the secondary market – The reporting requirements and taxation of life insurance policies sold on the secondary market (i.e. life settlements) are changed considerably by the legislation. However, the changes could make the policy sales more popular. A life settlement or what the Internal Revenue Code calls the commercial transfer (i.e. sale) of a life insurance policy (term or permanent) to a third party who has no insurable interest in the covered person. The purchaser cannot have a familial, business or financial relationship other than owning the policy. A policy’s value to a secondary purchaser is largely dependent on the medical condition of the insured but is attractive to investors looking for higher returns on other types of fixed income products. Life settlements took off during the AIDS crisis, when those with AIDS sold their life insurance policies to fund their costs for treatment. Since then, life settlements are more common. While still not a huge part of today’s insurance marketplace, the changes affecting life settlements could be significant to people who buy or sell policies. For a seller, such as someone who had a universal life policy with a sizeable cash value balance for estate planning purposes, but no longer believes they need it because of the above-mentioned changes, selling a policy on the secondary market may be appealing. For investors, the policies can offer higher returns than typically available from traditional fixed income securities.
  • The Tax Act made the secondary market more tempting by returning the tax treatment on life settlements to rules used prior to 2009. Since 2009, a seller was required to reduce the cost basis in a policy by the expired cost of the insurance. The Tax Cuts and Jobs Act now stipulates that the basis of a life insurance or annuity contract will no longer be adjusted for the expired insurance cost. The revised IRS reporting requirements apply to anyone who acquires or has an interest in a life insurance contract, directly or indirectly. Other changes impact taxation. For example, gains on term life insurance policy contract sales, without cash surrender value, are now long-term capital gains.
  • There are new rules for life insurance company reserves and deductions – The tax bill made changes that affect reserve accounts held by life insurance companies, their capitalization and amortization. Reserves are funds insurance companies set aside to pay claims based on numbers of policyholders, potential benefits and other factors. In other words, the reserves are cash they hold to settle future obligations. The 2017 legislation included new rules for how they are treated on corporate taxes. However, the reduction in the corporate tax rates for most insurance companies could offset the changes made to the tax treatment of life insurance reserve accounts and the ability to use them as deductions. While this might seem like arcane knowledge for the general public, the change is expected to offset the reserve account and deduction changes, which could mean an increase in an insurance company’s income and ultimately lead to better deals for consumers on insurance products.

Value As A Planning Tool

Life insurance is an important financial planning tool. While you may think of it as protection for a family in the event of a death, it has considerable value for business continuation, estate planning and even retirement planning purposes, which has not changed with the passage of the Tax Cuts and Jobs Act.

When planning for this year’s taxes, consult with a financial advisor with expertise on life insurance, such as Factum Financial. You want to talk with someone who specializes in using insurance products for building wealth for you and your heirs.

Factum, for example, helps clients maximize the results they get over time from a policy purchase, so life insurance is a life financial tool versus something accessed upon death.

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