American Taxpayer Relief Act of 2012 — How life insurance can remain a solution
April 1, 2013 by John F. Elder
On January 1, 2013, the American Taxpayer Relief Act of 2012 (ATRA) was passed by the House. ATRA provides for numerous tax increases. The information below provides a summary of the important provisions impacting your clients and explains how life insurance may continue to represent a viable solution to mitigate many of these tax increases.
Income tax provisions
Tax increase: Tax rates will permanently rise for families with income above $450,000 and individuals above $400,000 to 39.6 percent (up from 35 percent). All incomes below the threshold will permanently be taxed at Bush-era rates. Personal exemption phase-out (PEP) and the itemized deduction limitation (Pease) are re-imposed and set at $250,000 for singles and $300,000 for families.The 2 percent payroll tax cut, enacted during the economic slowdown, expired as of December 31, 2012. This represents a tax increase for over 70 percent of U.S. workers. The alternative minimum tax will be permanently patched (retroactive to 2012 and indexed for inflation) to avoid raising taxes on the middle class.
Role of life insurance: Life insurance should never be considered purely as an investment. However, it can be an integral part of a taxpayer’s financial portfolio and may now be even more important for families expecting to pay more in taxes. Life insurance provides diversification and tax-deferred accumulation. Further, policy owners may borrow or take withdrawals, potentially eliminating any taxation as long as the policy remains in force. Many contracts even offer an over loan protection rider. (Policy riders are available at an additional cost and may not be available for all products. Terms and conditions apply.)
Tax increase: Capital gains and qualified dividends are set at 20 percent (up from 15 percent) for those with incomes above the $450,000/$400,000 threshold, and at 15 percent for everyone else.
Role of life insurance: With taxes increasing on dividends (and interest income, as discussed below), individuals should consider including life insurance as an asset class as a part of their diversified portfolio.
Tax increase: Non-grantor trusts and “B” trusts will experience more dramatic income and capital gains tax increases than individuals due to the compressed rates applicable to trusts.
Role of life insurance: With income and capital gain tax increases, trustees ought to consider including life insurance as an asset class as a part of their diversified portfolio.
Tax Increase: Qualified charitable distributions of up to $100,000 from IRA’s to public charities are excluded from the plan participant’s income.
Role of life insurance: Provided that an insurable interest exists, the charity may leverage the contribution with life insurance on the donor’s life. Transfer tax provisions
Tax increase: The annual gift tax exclusion for 2013 is $14,000 (up from $13,000).
Role of life insurance: An annual gift of $14,000 per year can purchase a relatively large death benefit vis-à-vis the annual premium. For example, an annual premium of $14,000 can purchase $1,280,959 of survivorship death benefit protection on a 65-year-old couple.1
Tax increase: The maximum estate, gift and generation-skipping trust (GST) tax rate is 40 percent (up from 35 percent) with a $5 million exemption indexed to inflation (currently $5.25 million up from $5.12 million in 2012, and estimated to be somewhere near $7.5 million in 2022).
Role of life insurance: Families will be able to make additional tax-free gifts which can be leveraged with life insurance. For example, a married couple can purchase $8,896,932 of coverage for just $200,000 per year for 10 years.2 This is especially valuable for families that have utilized their entire exemption.
Other important income tax provisions for 2013 and beyond
Tax increase: A new 3.8 percent surtax applies to net investment income, which is passive income such as income from interest, dividends, annuities, royalties and rents (other than rental income derived in the ordinary course of a trade or business), and sales of non-business property. The tax applies to the lesser of the income attributable to investment income or the amount by which the taxpayers’ AGI exceeds the threshold limits in the health care bill ($200,000/individual and $250,000/married couple). Medicare wages paid in excess of $200,000 are subject to an extra 0.9 percent Medicare tax (employers will not pay the extra tax).
Role of life insurance: Life insurance cash values grow tax-deferred and can be accessed in a tax-favored manner by withdrawing from or borrowing against the cash values, potentially avoiding taxes, provided that the policy remains in force. As stated above, many policies offer an over loan protection rider.
1 Based on a Principal Financial Group Survivorship Universal Life Protector II illustration run for a male client age 65 at preferred nontobacco and a female client age 65 at preferred nontobacco in the state of Maryland. Run on January 2, 2013.
2 Based on a 10-pay Prudential PruLife® SUL Protector illustration run for a male client age 60 at preferred nontobacco and a female client age 60 at preferred nontobacco in the state of Illinois. Run on January 7, 2013.