The Modern Estate Plan?

Since the creation of the Federal Estate Tax in 1916, American families have been doing whatever possible to mitigate or shield their estates from erosion resulting from those taxes.  Since its inception the Federal Estate Tax has varied in its severity, with the top tax rate reaching as high as 77% in 1941.  On January 1, 2013, the American Taxpayer Relief Act of 2012 was passed which made the Federal Estate Tax exemption $5 million per person, permanent for tax years 2013 and beyond, meaning the vast majority of Americans would no longer be subject to any Federal Estate Tax.  

With most estates well below the new threshold, the advisory community appears to have come to the conclusion that estate planning, as we knew it, ceased to be an important topic for the typical American family.   However, even though the erosion of an estate due to taxes appears to be under control, has the Federal Estate Tax been replaced, if you will, with a new, more onerous villain; one whose hand will reach into the pockets of even the most modest of estates?  

Life expectancy rising faster than ever and with it comes a greater risk, the risk that Healthcare In Retirement may become a greater threat to estate erosion than any tax.  Today, perhaps discussions among advisors and their clients should now focus on "The Modern Estate Plan".

A Quick Examination of Estate Planning – Past & Present:   In the spring of 2000, Sam & Sally Saver turned 50 years old and with their three children out of college they turned their attention to retirement and estate planning.  With a thriving business their current estate was valued at approximately $2 million and their advisors estimated that at 3% growth rate it would increase to more than $6 million by age 90.   Based on input from their advisors, including their CPA, attorney and investment advisor, it was concluded that at age 90, their estate tax liability would amount to roughly $2 million. 

 Their next step was to create an Irrevocable Life Insurance Trust (ILIT).  Once in place, the Sam & Sally began funding a survivorship life insurance policy with a $2 million death benefit as, according to PriceWaterhouseCoopers, the ILIT would be “one of the best estate-planning tools available” and it is a “key vehicle for letting large portions of an estate escape estate, gift, and generation-skipping transfer tax permanently”.   Problem identified, problem solved….

The Realities of Estate Erosion from Healthcare Expenses:   Now age 65 and entering retirement, Sam & Sally have decided to review their financial planning as they’ve seen first-hand the impact of healthcare expenses for their parents.  Sally’s mother, Shirley, was diagnosed with Alzheimer’s in 2009 and spent nearly all of Shirley’s retirement assets paying for her Long-Term Care and nursing home expenses until she passed away in 2014. 

 Additionally, the couple has done their research and now has some concerns today which are different than those when they created their estate plan 15 years prior.  Fidelity Benefits Consulting estimates that those retiring in 2014 will spend, on average, $220,000 for healthcare expenses throughout retirement.  Cognizant of that number or not, it’s not surprising that Boomers “rank health care expenses as their top financial worry in retirement”, according to Merrill Lynch and AgeWave Consulting.  

Sam & Sally are quite comfortable after transitioning out of their business and selling it to their oldest daughter.  However, they are unsure if they should continue to fund their ILIT and insurance policy as it is unlikely their estate will be subject to Estate Taxes based on the 2013 changes.

They are also very concerned that future healthcare expenses might become inflict more estate erosion damage than their estate taxes ever could; especially after their experience with Sally’s mother.  Their advisors never discussed potential future healthcare costs, and whenever there was a cursory mention of Long-Term Care it was glossed over with a recommendation that the couple could “self-insure” and it was better to use their cash flow for the ILIT and estate planning purposes.

The Modern Estate Plan At Work:   Sam & Sally decide to engage another financial advisor to discuss their concerns to determine if there might be a better strategy for their ILIT and sizable cash accumulation in life insurance policy owned by the ILIT.  After a number of discussions, and detailed analysis of the ILIL and SVUL, the new advisor was prepared to make her recommendations.

•  She made is clear that terminating the ILIT could result in gift, estate, generation-skipping tax, and even income tax consequences. 
•  Next, in her assessment, the new advisor noted that the performance of their insurance policy in the ILIT, provided roughly $650,000 which might be put to use more effectively and alleviate their concerns. 
•  Lastly, she it to be understood that even though their assets did not exceed the current estate tax threshold, there is no guarantee what the threshold would be when they actually pass away.  
•  While the Federal Estate Tax was made "permanent" in January, 2013, the Estate Tax has been, and likely will be, subject to debate and changes in the future.  So, assuming the estate taxes will remain unchanged in the future could be a very expensive mistake.  

Ultimately, her recommendations were as follows:

• Continue to fund the ILIT but at a lower amount, but do so with their new “Estate Planning” goals in mind with respect to addressing their potential Long-Term Care needs.

•  Move part of the existing cash value in the Survivorship Life Policy (via a 1035 exchange) into a Hybrid Life/LTC solution to provide $12,000 per month of current benefits, growing with a 5% inflation protection option.  In the event Long-Term Care is never needed, a $300,000 death benefit would be available for the ILIT and its beneficiaries. 
• Move the remaining cash value in the existing policy (also via 1035 exchange) into a "paid-up" Survivorship policy which could provide a $1.4 million death benefit.  The ILIT owned death benefit would be available in the event a future Congress lowered the Federal Estate Tax.

With the evolution of financial planning, at some point, even those with modest assets need to ask their advisors a very important question:   “Although estate taxes aren’t a concern right now, should we consider “The Modern Estate Plan?”