The Estate Tax is set for a nasty reset come the end of this year if Congress does not act to extend current legislation, or create new. We've steered clear of political discussions on the Insurance Pro Blog, and we still intend to do that. Today's discussion will attempt to be as objective on the topic as possible, and bring our perspective to the table about what a regression to a $1 million dollar exemption and a 55% top marginal rate will mean to you.
The Gross Estate
When you die, a calculation is made to determine your gross estate. The only way around this is to have a spouse (who is an American citizen) to receive all of your estate through the unlimited spousal transfer. This process is (without diving into finite legal detail) a default option a lot of Americans use. For many it's not a big deal. With the current estate tax exemption at $5 million, it's going to take a long time for the average Joe and Jane to accumulate enough assets to touch this number.
However, since this is the sort of thing you won't learn in a basic finance class, and it's something a lot of Americans need to be aware of–and prepare for long advance–you should walk away from this post understanding that when you die (barring a spousal transfer) the IRS will require someone tally up all your stuff and calculate the appropriate taxes due on that stuff if applicable.
Appropriate Taxes Due?
Yes, sometimes it costs more money to die than you might think. Currently for American's holding assets in access of $5 million dollars the difference between the sum of those assets and $5 million is subject to the U.S. Federal Estate Tax at a rate of 35%.
Examples Always Help
Let's say old Grandfather Mort has assets totaling $10 million. We all know that when the old geezer finally kicks the can, there's some money headed our way. But how much?
Well, if grandpa has done a lousy estate planning job, much less than we might think. You see, when he dies (assuming he has no spouse, and personally owns all of these assets) he'll owe the IRS $1,750,000 in Federal Estate Taxes. And next year that tax bill will be $4,950,000.
We get there with the following equation:
Come 2013 the exemption is set to be $1 million and the top marginal tax rate will be 55%. This will dramatically increase Federal Estate Taxes due.
It's not just for Rich People anymore
While conservatives have rallied against the Estate Tax (they like calling it the “death tax”) for years, they always frame the situation in a way that doesn't speak to a lot of people. Recently the way right-wing lobbying group American for Tax Reform released a piece on all of the tax increases 2013 will bring if no action is taken, and their depiction of people easily effected by the Estate Tax are those owning two homes and having a retirement account.
It's no wonder many people are less sympathetic.
That's not to say those who have earned enough money to purchase two homes don't deserve them (I'm very much not of that opinion), but let's drop the status symbol BS for a minute and start talking about how this really effects people.
Life Insurance
Life insurance policies are included in the Gross Estate of the deceased owner/insured. They are received tax free (i.e. the IRS isn't going to ask the beneficiary to pay any money) but the death benefit itself is included in the Gross Estate of the deceased and is subject to Estate Taxes.
Imagine for a minute that you earn $150k per year and you've taken the quick rule of thumb advice from the standard financial advisor to purchase 10x your current annual income in life insurance ($1.5 million). Excluding your house (if you own one) and your other savings (what's in the bank, your 401k, etc.) you'll likely be sharing more than half of $500k of your death benefit with Uncle Sam if we return the old Estate Tax exemption and rates.
For those holding highly skilled professional degrees (the ones that come with six figure student loans to match the expected six figure salaries) you could be easily earning enough to push any reasonable life insurance purchase into Estate Tax territory.
Let's pretend for a minute that we look at the actual life insurance need or (God forbid) the Human Life Value purchase of life insurance for an individual. You don't need to earn six figures in that case to be in Estate Tax territory. And keep in mind, we're just talking life insurance at the moment, we then have to go back and add all of your other assets as well.
What to do?
There's no one simple answer to this situation. And the complexity of options goes way beyond the scope of this post. We will however be discussing some options in the very near future. For now, the best piece of advice I can give anyone is write your member of Congress and ask him or her to support legislation that will keep the Federal Estate Tax at it's current level. Even at $5 million it hits some people much quicker than we'd like, but at $1 million the Estate Tax will raid the piggy bank on way too many additional, and undeserving, Americans.
