If you make a living selling financial products to high net worth clientele, your success or failure in any given year is inextricably tied to the U.S. tax code. Whether it’s life insurance, annuities, stocks, bonds or any other product, contract or construct, the need for or desire to own the products you sell relies on your client’s perception of the current and future tax implications. And the tax code is a rapidly moving target. 

The highly politicized tax environment we are in right now shows no sign of abating, making it extremely difficult to provide advice for any period longer than one legislative session. And the very public social discourse about these topics tends to obfuscate changes that are simply too important to ignore. 

Take, for example, the laws regarding the estate tax. 

Like it or not, the estate tax is a political punching bag that has caused mass confusion over time. It never goes away (although it does temporarily sunset), but your heir’s chances of being affected by it, as well as the degree to which they are affected, are as random as a coin toss. Unfortunately, its purpose, in the grand scheme of socioeconomic engineering, has been hijacked by political hacks as a convenient boogeyman to scare wealthy voters. 

So, if your clients happen to die when the law sunsets, their estate could be almost totally exempt from estate tax (such as what happened with George Steinbrenner in 2010), or they could be unlucky enough to die in a year in which the exemptions are unusually low, leaving their estate owing a boatload of taxes. It’s a total crap shoot. Make gifts that use up the (potentially) excess gift tax exemptions. It’s a use-them-or-lose-them proposition. A tax-free gift to a trust that owns life insurance can potentially avoid all taxation. 

From a life insurance perspective, the last iteration of the estate tax exemption was particularly devastating to our sales. A unified credit of $23 million exempts an awful lot of estates from tax. And those clients who previously had been subject to the tax have been dropping survivorship policies because they are convinced that their estates are safe from taxation, based on the law as it stands today. I’m not sure they understand that they and their spouses need to die this year to make that true.  

Recently, I’ve had older clients drop or sell their multimillion-dollar survivorship policies because they’re convinced they won’t need them. Some of them are right. Their estates are just not big enough to be subject to estate tax, primarily because they lived so much longer than they or their children anticipated and had the time to gift or spend their assets. Somewhere down the line, the others will realize that the policies were valuable and should have been retained, but they will be unable to repurchase that coverage at anywhere near the price they were paying previously, if they can get coverage at all.

The tax on ordinary income is another good example of a moving target.

Rates of taxation in retirement are one of the key elements of assembling assets to meet the longevity risk. And it’s entirely possible that in the relatively near term, the rates and methods of taxation on capital gains, ordinary income, etc., may change significantly. But, realistically, there is no possible way to know what rate of taxes you might pay decades in the future. 

Politics is always the wild card.

Further complicating matters is the political environment, where any semblance of truth has long departed. How do you plan for the future in an environment where logic and math are completely ignored? Do we all want to pay lower taxes? Of course. Will newly minted trillion-dollar deficits related to, among other things, a global pandemic be repaid by magical thinking, or will we all need to contribute to the cost via higher taxes? My guess is the latter.

Your feelings about government and taxes notwithstanding, it seems that the prevailing attitude among advisors and their very wealthy clients is that taxes must go up in order to repay the enormous debt that will be the legacy of the current administration. Which taxes will change, and to what degree? Who knows? This is not a system you can game. You can only plan for the worst and hope for the best.

Taxes are a permanent problem.

The wishful thinking that we will have a robust economy and responsible governance thus resulting in lower taxes for decades is a fairy tale. Now would be good time to start looking at tax planning while the exemptions and favorable tax rates are still available. For example:

» Create a spousal lifetime access trust, and fund it with an overfunded, high cash value product.

» Start a life insurance retirement plan, and fund it with variable life insurance.

» Make a large charitable contribution.

» Start a private placement life insurance policy, and use it for retirement income.

If your clients see the products you sell as a fix for a temporary problem, they are going to be wasting a ton of money. Insurance products work best when policies are purchased properly, with adequate (and hopefully more than adequate) disclosures about the specific risks and rewards. Insurance is designed for the long term and should be understood as such. Not to mention that the beneficial tax treatment enjoyed by life insurance products is the gift that keeps on giving. 

Sold responsibly, our products provide a reasonable return on investment. Even in a low interest rate environment. It is reasonable and responsible to use life insurance as the anchor in a well-managed portfolio if the policy is properly structured. For example, this would be a good time to leverage taxable accounts into tax-free long-term care benefits.

Maybe, instead of constantly changing course, we could help our clients understand and use their life insurance policies for a variety of timely and beneficial purposes so that they won’t perceive insurance as a commodity. Nothing is better than seeing your clients benefit from your recommendations, especially when it comes at the most opportune moment. 

Last but not least, we seem to be at an economic inflection point. Regardless of what happens politically, the way we understand taxes today must change. Life insurance happens to be one of the very few products that offer reliable tax benefits and the flexibility to use them for a variety of valuable purposes. Let’s take advantage of this opportunity while we can.

Spousal Lifetime Access Trust

Once established and funded, the trust may purchase insurance on the life of the beneficial spouse. Any high cash value accumulation product can be used, subject to suitability constraints. 

Depending on the types of assets contributed to the trust, the grantor may have a tax liability for any capital gains or ordinary income that accrues. But if you monetize those assets and contribute cash to purchase — for example, a variable life policy — you can effectively shield the asset and all of the growth from taxation forever. 

In addition, if properly funded and managed, a cash accumulation product will provide for tax- free income to the trust beneficiary (spouse) when necessary or desired. In addition, the grantor may want to purchase a term insurance policy on the trust beneficiary, because if the beneficiary were to die before using all of the assets of the trust, any remaining assets will pass to the children (or other designated secondary beneficiary) but not to the grantor. So, in the case of a divorce or premature death, the term insurance returns the asset to the grantor. 

When you model this out, especially in a high tax state, the benefits of the life insurance policy and its tax-favored deferral and distribution are hard to argue with.

The Life Insurance Retirement Plan

A private placement variable life insurance on the executive’s life can provide a great way to solve several issues. 

First, it replaces the lost coverage from the group plan at a much more competitive cost. Second, it can be funded as a nonmodified endowment contract, up to the IRS limits, and provide tax-deferred growth and tax-free income in retirement. We recommend the insured be the owner if the main purpose is tax-favored retirement income. Or the policy could be owned by a trust so that the growth and any excess death benefit can be passed to heirs outside of
the taxable estate.

The secret sauce to PPVLI is the underlying portfolio of hedge funds. Most funds are very tax-inefficient. Wrap these funds in PPVLI to eliminate the tax problem. The objection we hear most from clients is that the cost of insurance makes the PPVLI an expensive alternative. I disagree. The correct way is to compare the actual policy costs with the future taxes. When you do this the PPVLI shines, especially in an increased tax environment. 

PPVLI has very high minimum premiums, usually $500,000 per year for seven years. Most are funded with multiple millions, so this will not be suitable for every client. 

Ron Sussman is founder and chief executive officer of CPI Companies. Ron may be contacted at [email protected].