Advisers Revisit Estate-Tax Insurance

Arden Dale for the Wall St Journal writes: Now that Uncle Sam won't be taxing as many estates, financial advisers and their clients are strategizing on what to do with life insurance policies they took out to help beneficiaries pay estate taxes.

Using life insurance to cover estate taxes has been a common practice to ensure that heirs aren't forced to sell assets like real estate or a business. Generally, the policy is held in an irrevocable life insurance trust.

However, constant changes to federal tax rules have left a lot of people with insurance they may no longer need.

As of 2013, there's a higher estate-tax exemption that will get higher each year because it's adjusted for inflation. Only estates of $5.25 million ($10.5 million for couples) and over are taxable this year. In 2001, the exemption was $675,000 and has been rising steadily expect for 2010 when Congress repealed it for a year.

For anyone who bought a such a policy earlier in the decade, the ever increasing tax exemption poses a dilemma: drop the policy or use it for other purposes?

"I used to set up irrevocable insurance trusts for married couples with $2 million to $5 million estates all the time a decade ago," said Edwin P. Morrow III, a Dayton, Ohio-based manager of wealth strategies communications at Key Private Bank.

Recently, Mr. Morrow worked with a couple worth between $8 and $9 million who no longer needed an irrevocable life insurance trust for estate taxes. They collaborated with the trustee to convert it--using tax rules known as a 1035 exchange--to a new policy that will benefit their son.

A lot of advisers are talking about using the 1035 exchange, which allows the transfer of funds from existing policies to annuities or new insurance policies without reporting taxable income.

Rob Lemmons, an adviser at Financial Management Group in Cincinnati with $300 million under management, said he's exploring whether his older clients could benefit by using a 1035 exchange to get long-term care insurance.

"The cost of long-term care is a greater risk to them financially than a death would be," he said.

Many estate-tax policies become more efficient after time, which can be part of an argument for keeping them. Dividends a policy earns may offset premium payments, and if the policyholder's health is bad, the return on the death benefit for the beneficiaries may be greater than if the policy was surrendered for its cash value, Mr. Lemmons said.

A client of adviser James Guarino in Tewksbury, Mass., decided to keep an irrevocable life insurance trust even though his estate is worth less than $5.25 million. His goal: To give his heirs the death benefit that's free of income taxes.

"It's a pretty lucrative benefit," said Mr. Guarino, a tax partner and financial planner at MFA - Moody, Famiglietti & Andronico LLP.

On the other hand, some advisers look at purging policies. A reason to do that might be because the policyholder wants to use money spent on premiums for other purposes like living expenses or helping a child, said James Ciprich, an adviser at RegentAtlantic in Morristown, N.J., with about $2.4 billion under management.

"Some of my clients with a net worth below $10.5 million have maintained their policies, but there are still some valid reasons to consider surrendering a policy," Mr. Ciprich said.

But Dana Anspach, an adviser with Sensible Money in Scottsdale, Ariz., which manages $52 million, said insurance agents are telling some of her clients that they still need the insurance for estate taxes.

"I'll come back and say I really don't think you do," she said.