What’s that they say about crisis and opportunity being the same thing?
It turns out that Americans spooked by the prospect of President Joe Biden’s proposed tax increase on capital gains could turn the fear of handing their life’s savings over to the government into an innovative workaround.
The solution isn’t some complicated loophole hiding deep in the guts of American tax laws, either. It’s life insurance.
Here’s how purchasing the right life policy can help your family hold onto more of what they’ve got coming to them.
Why are taxes on inheritances set to rise?
Biden has some big plans for his administration, particularly two giant spending bills concerned with improving the country’s aging infrastructure and providing a post-pandemic boost to employment.
But with the proposed cost of those two bills being more than $4 trillion, the president has to find some way to pay for them.
Biden has suggested a spate of tax increases that are projected to generate more than $1 trillion in revenue: returning the top individual tax rate to 39.6%, increasing the corporate tax rate from 21% to 28% and doubling the capital gains tax rate from 20% to 39.6% for individuals earning $1 million or more in annual income.
Factor in the 3.8% Net Investment Income Tax high earners are required to pay in capital gains and they could be looking at a total capital gains tax rate of 43.4%. A related Biden strategy involves taxing capital gains on inherited property at death.
Rather than allowing heirs to defer taxes on inherited property until they sell it, this particular proposal would see the transfer of assets from deceased to heir treated like a sale.
So if an inherited property’s value is found to have grown by more than $1 million between when it was originally purchased and when it was inherited, the heirs could be hit with the newly hiked capital gains levy right away — no deferment.
Let’s say you’re passing a swath of valuable farmland down to your daughter. Since you purchased it 20 years ago, its value has increased by $2 million.
That increase could result in as much as $434,000 in immediate capital gains taxes, even allowing for the $1 million and not including state and local taxes.
How life insurance can counter capital gains taxes
Those capital gains increases aren’t set in stone. Any bill that includes them will face stiff resistance in both the House and Senate.
But if the increases do survive the congressional spanking machine, you can get around them by purchasing the right life insurance policy.
For big earners
If you were to transfer more than $11.7 million to your family, you could look into an irrevocable life insurance trust (ILIT), which controls your life insurance policy while you’re alive and distributes your assets once you join the great abyss.
When an ILIT owns and controls your life insurance policy, the proceeds from your death benefit are not considered part of your gross estate and won’t be taxable at either the federal or state level.
ILIT’s can also provide the kind of cash needed to pay estate taxes and other expenses. They’re more complex than your average insurance policy, so make sure you get advice from a trusted insurance provider.
For everyone else
If your family is facing a potentially mammoth capital tax hit once you’re gone, taking out a large enough life insurance policy could help ensure your life savings don’t evaporate after you’re gone.
The first thing you’ll want to do is get your assets appraised to determine how much they have appreciated over the years. That’ll give you an idea of how big your capital gains bill might be.
Once you have a dollar amount to work with, you can explore taking out a life insurance policy that pays out an amount equal to, or greater than, your capital gains costs.
You can opt for either term or permanent policies. Permanent policies, which cover you until death, tend to be more expensive.
Term policies are often cheaper, and because they cover a shorter period of time, may be a better hedge against Biden’s plans falling through.
Other ways to provide for your family
If taking out a hefty life insurance policy isn’t in the cards, there are other ways to help your family cover the costs associated with your passing.
If you’re a homeowner and you haven’t refinanced your mortgage in the last year, you could be leaving a mountain of money on the table. With rates below 3%, mortgage data and technology provider Black Knight found that 14.1 million homeowners could save an average of $287 a month with a refi. That’s money you can funnel straight into savings vehicles and investments for your family.
Choosing which assets are most likely to pay off over the long-term can be overwhelming if you’re not a market hound or finance nerd. It can be tempting to get your investing advice from social media, but you should always take the time to get your investment and retirement planning advice from professionals who know what they’re doing.
Some investing, however, is simple and low-risk enough that anyone can do it. Taking a run at today’s booming stock market, for example, can be as simple as downloading an app that allows you to invest in a diversified portfolio using “spare change” from your everyday purchases.
Just remember to set aside a chunk of your earnings -- possibly a big one -- for Uncle Sam.