2018 UPDATE: We have a more recent article on this topic, check it out here!
Quick Article Guide
- Estate Tax Exemption History
- Estate Planning to Avoid Estate Taxes
- Estate Tax Calculator
- Best Life Insurance Coverage for Estate Planning
In October of 2015, the IRS announced the estate tax exemptions for 2016.
As expected, the estate tax exemption limit increased again slightly this year, but was it enough?
For most of the affluent clients we work with, their estate is growing faster than the IRS estate tax exemption.
To prevent your heirs from paying your life’s work back to the IRS when you pass away, you need to create an influx of cash to settle these taxes. In this article, we will show you how affluent Americans reduce their liability to Uncle Sam with life insurance.
Every year in the fall, the IRS announces their changes to the estate tax exemption and gift tax limits for the upcoming year. You may have paid attention to this over the years if your estate or total assets are worth more than $5,000,000. For the past six to seven years the IRS has been slowly increasing the amount of the estate tax exemption and the estate tax rates.
Although the IRS has been following this trend, there are no guarantees that the rise in rates will continue. What’s more important to notice is the potential gap that these charts illustrate. For example, let’s say in the year 2011 your estate was worth $5,000,000. If your assets are like most, they should be accumulating interest or growing at some rate or return. This is true whether your investments are in property on money markets, annuities, stocks, mutual funds, etc.
If your assets are growing at a modest rate, say 5% or 10%, let’s watch what has happened over the last few years.
Under this assumed model, you can see how the growth of your assets will outpace the growth of the tax exemption schedule created by the IRS.
If your estate is currently worth more than $3,000,000, it’s probably safe to assume that your estate will have an estate tax liability within ten years. Even in a shaky housing market, property values still tend to double every decade or so.
For this reason, most financial advisors recommend some form of an estate plan for anyone under the age of 60 that has an estate valued at $2,000,000 or more. The average lifetime expectancy for an American male is roughly 81 years old and females are predicted to live even longer. If you are in your 50’s now, you can probably expect to see at least 25 years of growth, and generally speaking, the value of your estate will double every 10 years.
Example: If you are a 51 year old male, your life expectancy is 81 which means you are expected to live 30 more years. By using this scenario, we can quickly determine how much your estate will be valued at your time of death.
In order to do this, you must take the number of years you have left to live, which in this example is 30, and divide that number by the amount of years it will take for your estate to double (10 years). The final number represents the amount of times your estate is expected to double in value. In this case, after doing some simple math, you will discover that the final number is 3, which means the estate in our example will double in value a total of three times.
If your estate is worth $2,000,000 in 2016, with favorable growth, you can expect your estate to be worth as much as $4,000,000 in 2026, $8,000,000 in 2036, and as much as, $16,000,000 in 2046, when you reach your 80’s.
This scenario may seem unbelievable, but even if your estate grows at half of this rate, it may still incur some federal estate taxes. This does not account for each state’s inheritance tax rate.
If you’re uncertain, please use our estate tax calculator to better understand and estimate your estate tax liability.
In order to help your heirs avoid potential estate taxes when you pass away, you can purchase a permanent life insurance policy to reduce your estate tax liability. The proceeds of your life insurance policy will create an influx of tax-free cash to pay your estate taxes when needed. It should be noted that in order to avoid estate taxes with life insurance, your life insurance policy CANNOT expire before you do. This means you cannot buy term life insurance for estate planning because term life insurance does not provide permanent coverage.
If longevity occurs in your family and you want to lock in a policy that offers life insurance protection until at least the age of 90, we also have options that give a guaranteed rate and coverage until age 95, 100, 105, 110, 120, and 121. These policies work just like a term life insurance policy, but they guarantee your rates until a defined age instead of a set period of time (like 10, 15, 20, 25, or 30 years). The majority of term policies end by the age of 80, and most life insurance companies stop offering a 20-year term after the age of 60.
On the other hand, do not buy a life insurance policy that accumulates a cash value for estate planning, you will be wasting your money. In this case, you want a policy that will last your lifetime. If you pull the accumulated cash value out of your policy, you will have to pay it back with interest. Take it from the experts; keep your investments separate from your life insurance coverage. Don’t be tempted by those “prospective interest rates” your local agent shows you either. I have never met a client that earned them. Ask to see the “guaranteed interest rates” and then account for the management fees, increasing cost of coverage that draws from your cash value over time, and the cash surrender fee. Like Bob Brinker and Dave Ramsey will tell you, you’re better off stuffing that money into your mattress.
We recommend buying a guaranteed universal life insurance policy with guaranteed rates and coverage until the age of your choice. These policies are the least expensive form of permanent life insurance coverage on the market and they do not require an additional investment to build a cash value.
Use this money to pay off your investment properties earlier, or invest the extra money each month into an investment with better interest rates or more flexibility.
When purchasing your life insurance policy, you will need to start the process by creating an Irrevocable Life Insurance Trust. We explain the entire process of creating an “ILIT” here, or you can learn about the different types of trusts used in estate planning with life insurance in our life insurance trusts article.
Here is How It Works:
Start by creating an Irrevocable Life Insurance Trust by calling a Trust / Estate Attorney.
Your Attorney will need the following information:
- Name of Trustee: Who will oversee your estate when you pass away and carry out your final wishes? (Usually this is a trusted family member or an executive of your bank).
- Name(s) of your beneficiary or beneficiaries: Who do you want to leave your estate behind to? Your spouse, children, church, charity, or business partners?
- Open a bank account in the name of your trust: This policy will fund your estate policy; you can deposit up to $14,000 per year, as of 2016, as your Gift Tax Exclusion to fund the policy tax-free.
- Calculate the amount of coverage you anticipate you’ll need to protect your estate: You can do this by using the simple calculations above or use our estate planning calculator for a better estimate.
- Apply for coverage: Shop the market for a permanent policy that does not build a cash value. We can provide you with quotes from the top companies available to you and we’ll provide you with pricing options until the age of 90, 95, 100, 105, 110, and 121. In addition, we work with over 40 companies so we can save you time and money.
If you’re not sure how to calculate the coverage amount you need, feel free to give us a call. With a few questions, we’ll be able to help you determine the best amount of coverage to buy. Applying for too much coverage is better than not enough and the insurance companies will allow you to adjust your policy at approval. Also, most life insurance companies allow you to decrease your coverage and cut costs after your policy has been inforce for one year, if needed. We can be reached, toll free, at (855) 247-9555.
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