Warren Hersch for Life Health Pro writes: With tax season now in full swing,
you may well be looking for opportunities to convert clients' and
prospects' heightened awareness of current or potential tax liabilities
to solutions that will help them attain their financial goals. You're not alone. Many life insurance and financial service professionals, observers tell NUL, generate
substantial business from planning opportunities stemming from tax
issues. Tax avoidance is an especially rich topic this year because of
the recently enacted American Taxpayer Relief Act of 2012, which ended the long-running sunset provisions on certain levies while boosting tax rates that will most impact the high net worth, though individuals in lower tax brackets may also be affected.
But as the 2013 tax year is already underway, advisors can do little
to affect clients' 2012 year tax liabilities, apart from serving in
"reactive mode," observes Richard Shakter, a CFP and principal of
Financial Compass Group LLC, Wellesley, Mass. The scope of work
includes, for example, reviewing documents to ensure the accuracy of
items reported on this year's IRS 1040 form and determining whether
tax-deductible items have been overlooked. Among them: income-producing
investments that clients may have forgotten about; appreciated stock
gifted to charities; debt service (interest deductions) and employee
benefits (medical deductions) items.
The main business opportunities, say experts, lie in leveraging tax season to help clients plan for next year's tax filing.
“The income tax return is an inventory of all of a client’s
assets—everything one own gets reported there,” say Herbert Daroff, a
CFP and principal of Baystate Financial Services, Boston, Mass. “So it’s
a good idea to review the document line by line with the client in
advance of tax season. As clients are thinking about paying income
taxes, now is a wonderful time to tell them, ‘As you prepare for your
2012 tax filings, let's see how we can help you reduce your 2013 tax
liability.”
And, he adds, it’s a good time to identify gaps in insurance
coverage. A review of interest rates and the durations of client debts,
may, for example, point up the need for additional life insurance,
disability income insurance or long-term care insurance to cover
outstanding liabilities in the event of a loss of income.
Leveraging such tax deductions to minimize one's tax liability is
good thing. The same cannot be said of tax refunds, which constitute
interest-free loans to the government, money that would be better
deployed elsewhere. The objective, says Daroff, should to be to maximize
net income and assets after taxes, inflation and fees, then decide how
to best to allocate the net after-tax income and assets.
2012 tax legislation
From an estate planning perspective,
observers say, The American Taxpayers Relief Act of 2012 is a
double-edged sword. Since the legislation provides significantly higher
estate tax exemption levels than under the pre-2001 estate tax regime —
$5 million per individual under the act versus $1 million per person
under the old regime — fewer clients need life insurance to pay for
estate tax. Conversely, clients looking to boost their legacy to heirs
may be able to purchase additional life insurance without crossing over
the estate planning threshold.
“Most Americans can now buy their life insurance with tax-deductible
dollars inside qualified plans and not worry about estate tax inclusion
of the death benefits,” says Daroff. “If I have a $2 million estate and
want to buy life $2 million of life insurance, I'm still under $5
million. So why not buy life insurance through a qualified plan?”
Daroff adds the higher estate tax exemption levels under the Relief Act should also make certain trust planning vehicles more attractive to
clients for income replacement purposes. Case in point: married couples
reducing the value of their estates while retaining control of income
for life by establishing a cross-spousal lifetime access trust.
To illustrate, a husband and wife can each creates a SLAT valued at
$10 million ($5 million in assets plus $5 million in life insurance) for
the benefit of the other. While alive, the couple generates income from
the aggregate $10 million in non-insurance assets placed in the two
trusts. At the death of the first spouse, $5 million in policy proceeds
are paid to the surviving spouse, thereby replacing income no longer
being generated from the trust established for the deceased.
The SLAT is available not only to married couples, notes Daroff.
Individuals that don’t qualify for the federal marital
deduction—co-habiting gays, lesbians and heterosexual couples, as well
as resident aliens—can also leverage a SLAT to care for a domestic
partner.
The higher tax rates on income, capital gains and dividends
stipulated under the Taxpayer Relief Act, say experts, should also spur
tax planning among singles and married couples earning more in annual
income than $400,000 and $450,000, respectively. Those looking to defer
income tax will have an even greater incentive than in past years to
leverage the tax-favored treatment of life insurance and annuities.
These vehicles, market-watchers suggest, will also be more attractive
to clients who in past years might have foregone tax-deferred vehicles.
The reason: It was less costly to pay capital gains or dividends tax on
the sale of securities than to pay income tax at the time of
distribution on a life insurance policy or annuity.
“When capital gains and dividends taxes were lower, income tax
deferral actually worked against the use of life insurance and
annuities,” says Terry Altman, a CFP and financial planner at Global
Financial Planning Group LLC, Troy, Mich. Financial professionals who
invoked income tax deferral as a reason to recommend annuities or life
insurance would lose an argument with a CPA opposed to these products —
and justifiably so — because income tax deferral was not in the client's
best interest.
“It's conceivable that going forward, income tax deferral may be as
attractive as it was in the 1980s or 1990s because of the rise in income
tax rates," he adds.
The case for tax-deferral
offered through non-qualified deferred compensation plans funded with
life insurance is particularly strong in client engagements involving
C-corporations, says Altman, because of the “brutally high” taxes these
companies might be subject to absent the planning. He adds Internal
Revenue Code Section 409A, finalized in 2009, has eased non-qualified
deferred comp planning by clarifying rules regarding the timing of
deferrals and distributions.
Market-watchers
also anticipate greater leveraging of income tax-deferred vehicles for
individual planning, and not only in respect to life insurance and
annuities. Also likely to attract greater interest are tax-qualified
individuals retirement accounts, including 401(k), 403(b) and other
ERISA-compliant profit-sharing plans, plus traditional IRAs and Roth
IRAs.
To be sure, life insurance can also play a role in mitigating the
potential tax bite for clients electing these retirement vehicles.
Baystate Financial’s Daroff says that an individual desiring to convert
an IRA to a Roth IRA can use life insurance to pay income tax on the
conversion at death, thereby boosting the income tax-free legacy for
heirs.
Enlisting the help of a CPA
Certified public accountants frequently are needed to help advisors address the tax implications
of such planning. This is particularly true, say experts, in cases
involving high net worth clients and small business owners who have to
consider how life insurance-funded arrangements might impact other
aspects of their financial plans or (in respect to a company) their
balance sheets. Life insurance-funded non-qualified deferred comp plans,
Section 162 executive bonus plans and split-dollar arrangements are
effective vehicles for recruiting, rewarding and retaining top talent.
But such arrangements may have to be jettisoned or postponed until, for
example, the business is better positioned from a cash flow perspective.
Enter the CPA, who can provide the expertise needed to address such
questions. Just don’t expect their services during tax season, either
because they’re too busy completing clients’ tax returns; or because the
life insurance professional doesn’t have a pre-existing alliance with
the CPA.
“If a life insurance agent wakes up February 1 and says ‘I want to
find a bunch of CPAs to work with,’ then he's about nine months too
late,” says Nick Hodges, a CPA, CFP and president of NCH Wealth
Advisors, Fullerton, Calif. “If you don't have a relationship with the
CPA well in advance of tax season, they won't give you the time of day
during tax season.”
The best time to build such partnerships, he adds, is during the
second or third quarter of the calendar year, when CPAs have more time
to review with the advisor entries on tax returns that might lend
themselves to planning. The only topics that CPAs and insurance
professions should discuss at tax time, observers say, are those
questions affecting the current year’s tax return.
To be sure, says Hodges, accountants will frequently uncover planning
opportunities when drafting tax returns, such as the need to adjust a
client’s financial objectives or cash position because he or she is no
longer employed; or because a business’s holdings of stocks and other
assets are not advantageous from a tax perspective. To the extent that
insurance professionals can acquaint partnering CPAs with planning
opportunities in advance of next year's tax season, the more profitable such alliances will be for both professionals.
The educational outreach need not be limited to private get-togethers
with CPA partners alone. Hodges notes that he recently offered to meet
jointly with 10 clients of a Texas-based CPA to allow him to see the
financial planning fact-finding process in action. The meetings yielded
several new clients for Hodges.
Favoring a more academic approach to alliance-building
is Baystate Financial Services. Daroff says that he regularly hosts
seminars for other professionals who can assist in complex planning
cases — attorneys, property and casualty agents, bank advisors, in
addition to CPAs — the program content focusing on trends and joint
opportunities in estate planning, retirement income distribution
planning and business succession planning. Result: These advisors have
become a key source of the firm’s referrals to client prospects.
He adds the new business arrives not only through introductions. Many
of the CPAs are also licensed to sell life insurance and securities
through, respectively, Baystate’s brokerage general-agent and
broker-dealer. They thus can share in insurance commissions and planning
fees resulting from a sale.
Does Baystate have established sales or referrals quotas for these
professionals? Daroff says “no,” observing that production goals are
“old hat.” He notes, however, that Baystate’s advisors are regularly in
contact with other professionals; and that splits in commissions and
fees are commensurate with a partner’s contribution to the client
engagement.
When determining compensation, Baystate frequently elects a formula
recommended by the Million Dollar Round Table, which pays the advisor 20
percent for securing the prospect; 20 percent for fact-finding and data
collection; 20 percent for designing plan recommendations; 20 percent
for executing the plan; and 20 percent for servicing the client. But the
compensation formula will vary; in many instances, a simple 50-50 split
is used.
Much of the time, agents and planners turn to CPAs solely for their
tax expertise, a knowledge base that is particularly valued in complex
wealth transfer and business planning cases. Establishing relationships
with outside CPAs insures ready access to such expertise in cases where,
for example, the client is without an accountant.
Still better is being able to tap that expertise in-house. Prior to
joining Global Financial Planning Group, Altman says that he was
employed by Rehmann, a firm that specialized in developing qualified and
non-qualified compensation plans for company employees. There, Altman
worked closely with accountants who, serving in the firm’s corporate
auditing arm, were able to deliver high-level expertise—and often on
cross-border tax questions. Example: Determining the U.S. and Canadian
tax treatment of income earned by Americans working in Canada, a common
issue among Rehman’s Michigan-based corporate clients.
In-house tax expertise was not always a good thing, however, for it
sometimes led to perceived conflicts of interest. In cases where the
firm’s accountants were auditing a company’s books, says Altman,
financial planning services had to be outsourced to an outside firm. The
alternative, doing the planning and outsourcing the auditing, was never
permitted—even in instances when it was more profitable to do
so—because the auditing practice was “very protective” of its business.
Altman no longer confronts such internal conflicts of interest in his
current practice. The obstacle now, he says, is to overcome biases
against life insurance and annuities among partnering CPAs, a particular
challenge when the accountant has a pre-existing relationship with the
client.
“CPAs have a tendency to immediately bristle at the mention of life
insurance and annuities because they’ve often been trained to hate the
products,” says Altman. “To have a productive relationship with the
accountant, you have to be ready to confront this prejudice head-on.
“You have to know your material and be able to articulate the
favorable usages of insurance-related products in a way that overcomes
their predisposition against using them. There are a lot of really smart
CPAs who don't understand how life insurance can assist in tax
planning.”
Saturday, March 23, 2013
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