3 Ways GOP Tax Bill Could Change Your Life Insurance

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After several months, Congressional Republicans have released a bill detailing a long-anticipated tax overhaul, including a proposed doubling of the estate tax exemption, followed by a complete phase-out of the federal estate tax altogether.

While it’s customary to think first of real-estate holdings, stock portfolios and the like when it comes to estates, many, of course, also include a payout from a life insurance policy.

The GOP’s proposals—in particular, the end to any estate tax—could also have a significant impact on how life insurance policyholders consider their potential tax burden in the future.

Here’s a rundown of how those changes might change the game when it comes to the taxation of estates.

Less need for maneuvers to avoid paying estate taxes

When you purchase a life insurance policy, you can name any number of beneficiaries. Those beneficiaries (be they family, friends, charities, etc.) will receive a payout if you pass away while covered by the policy. In most circumstances, your life insurance proceeds are added to the value of your estate for tax purposes.

At present, if the combined value of your life insurance when added to your estate exceeds a threshold of $5.49 million, any amount of that figure is subject to 40% tax. For 2018, even absent of any legislative changes, the amount is scheduled to rise to $5.6 million. (However, note that the life insurance proceeds do not pass onto the estate beyond taxation purposes, unless you didn’t specify beneficiaries or they passed away, so this amount does not go through probate.)

Those figures in themselves are high enough to spare almost all estates from being taxed. A 2015 Congressional study reported that only 0.2% of estates were subject to tax, which translates into just one of every 500 Americans who die.

The proposed increase of the limit is sure to further reduce the proportion of estates subject to tax. In turn, the change would also reduce the need for various methods by which you can avoid having your life insurance policy proceeds added to your estate value.  

One such move is to transfer ownership of the policy before you die. Through written consent, the new owner takes over the policy and becomes responsible for its premium payments.

Another method to avoid estate taxes is to transfer your life insurance policy to an irrevocable trust. Through this method, some of your assets, such as your life insurance policy, cash, and even a business, can be transferred to a trust with ownership given over to the trustee. Your beneficiaries can still receive the life insurance proceeds through the trust. All assets transferred to the trust are removed from your estate and are not included as part of your estate when estate taxes are assessed.

Possible further rule changes once the tax ends entirely

The GOP bill calls for the estate tax to end entirely on January 1, 2024. At that point, then, even families subject to the elevated limit would no longer run the risk that any life insurance policies they hold might be subject to taxation (unless they somehow become a part of your estate). Whoever receives the benefit of your estate afterward would receive the sum tax-free and intact, aside from claims by creditors.

Additionally, if your life insurance proceeds were taxable due to the Three-Year Rule, this also would probably no longer apply. So long as the estate tax is phased out, the Three-Year Rule (which taxes gifted amounts if the gifter passes away within 3 years of its first transfer) would likely also be phased out by consequence of this tax change.

A shift in focus to state estate taxes

While a proposed phase-out of estate taxes may bring some benefits to life insurance policy holders, it won’t eliminate all forms of estate tax. As of 2016, 14 states and the District of Columbia have their own estate taxes in place. Six states impose an inheritance tax, which taxes the beneficiary and not the estate. In the case of Maryland and New Jersey, both an estate tax and an inheritance tax are imposed.

State-level death taxes often have lower exemption thresholds than the federal estate tax. Thresholds vary, but can range from $1 million to $2 million before the estate incurs a tax burden. The percent you’ll have to pay in state-level estate taxes reach as high as 20% in Washington State, although most states with an estate tax have a tax rate that typically does not exceed 16%.

This content originally appeared on ValuePenguin

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Personal Finance , Insurance , Millennials , Politics , Taxes

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