Insurance Strategies in an Uncertain Tax Landscape

Michael DeFillipo, CLU® , ChFC®
Apr 19
8 min read

Updated: Apr 21

by Michael C. DeFillipo, CLU®, ChFC®, Partner, 1847 Private Client Group

We all know the popular idiom that “[n]othing is certain except death and taxes.” For financial and estate planners, there’s a second part to this truism: “Nothing is certain except death and taxes … and that we won’t know what the taxes are going to be when you die.”

Much of the discussion prior to the 2024 General Election was centered around the expiration of the TCJA, and with it, the looming sunset of the temporary (?) increase to the Federal Wealth Transfer Basic Exclusion Amount, hereafter referred to as the estate tax exemption. As we all know, if no action is taken by a united Republican government prior to the end of the calendar year, the exemption amount of $13,990,000 per individual will automatically revert back to $5,000,000 indexed for inflation, or an estimated $7,500,000 per person.

This potential change, and the magnitude of it, created a significant planning opportunity: use it or lose it. Making or not making significant gifts to a trust, e.g., an Irrevocable Life Insurance Trust or a Spousal Limited Access Trust, was a topic much discussion. From an insurance design perspective, practitioners and insurance companies were tasked with providing options to take advantage of the elevated exclusion amount while still providing flexibility should the insurance coverage not be needed due to a higher exclusion amount.

John Hancock instituted a program should the basic exclusion amount be $8 million per person or less in 2026 (reflecting the sunset of the exemption plus inflation), clients will have an option to purchase an additional policy without additional underwriting. The maximum face amount on the new policy will be equal to a maximum of the lesser of $5 million or the original policy face value. There is no charge for this feature in 2025 or to elect to exercise the option in 2026.

A popular insurance design was to utilize a “Wait-and-See” approach, using a permanent survivorship insurance policy funded by a single premium designed to carry the policy for a limited time to lock in current insurability and pricing. At some point in the future, depending upon changes to tax law and/or the client’s net worth and/or family situation, the insureds will determine whether to pay future premiums to increase the coverage, lapse or surrender the policy, or reduce and maintain some form of coverage.

At the time of this writing, many observers are in agreement that an extension will be passed sometime later this summer – with a majority of opinion being some time in August – that will give us another intermediate gift and exclusion amount from which to plan.[1]

What happens next year, or in the next four or ten years does not cement how we will advise clients decades from now.

Abridged History of the Federal Wealth Transfer Basic Exclusion Amount

Year	Amount or What Happened	Year	Amount or What Happened
1916	$50,000	2002	$1,000,000
1924	Gift Tax Enacted	2009	$3,500,000
1926	Gift Tax Repealed	2010	$0
1932	Gift Tax Re-enacted	2011	$5,000,000
1980	$161,000	2018	$11,180,000
1990	$600,000	2025	$13,990,000
2000	$675,000	2026	$???????????

Over the past 25 years, a timeframe that corresponds to the future planning being done by clients prior to expected mortality, the estate tax exemption has increased approximately 2000%.

Life Insurance Characteristics

A recent PEPC program speaker, Jay Judas, presented on “The Increase in Popularity of Private Placement Life Insurance as a Wealth Transfer Tool.” Jay’s presentation was a fantastic and informative look at a very specific product for the ultra-affluent as a solution for tax-inefficient assets that ultimately will be transferred to future generations.

However, it was a valuable reminder of the core characteristics of permanent life insurance that are applicable to retail products for a wide spectrum of high net worth and ultra-high net worth clients:

“The Three Thin Threads”
1. Income tax-free death benefits
2. Tax deferred inside buildup of cash value
3. Ability to remove death benefit proceeds from the taxable estate
Death Benefits are paid in cash
1. Claims are generally paid within days
2. No need for sale or valuation of illiquid or non-marketable assets
3. ‘Synthetic’ step-up in basis
Multiple avenues for policy disposition
1. Surrender value
2. Charitable transfer
3. Secondary marketplace (Jamie Mendelsohn’s presentation at the January PEPC event on “Maximizing Life Settlement Value Through a Policy Auction” provided great insight on the topic.)
Provides a hedge against premature death and volatility in other assets, stabilizing the transfer of wealth.

Life Insurance as an Asset Class

When removing the intent to use life insurance solely as a means to “pay for the tax,” we are able to consider the financial tool as another legacy or wealth transfer asset class, and evaluate the strategy as part of the overall asset allocation by measuring the specific risk-adjusted expected return on the insurance and its impact on the overall portfolio.

As a long-term asset, the most common means for identifying the projected outcome of the insurance design is to look at the Internal Rate of Return (“IRR”) of the death benefit in relation to the premiums paid at expected mortality. Life insurance pricing is based upon the actuarial tables using average age of death for cohorts of similar age, gender and risk classification; by using those tables to provide a starting point for expected mortality, the policy owner can see the anticipated return on investment by observing the IRRs at life expectancy (“LE”) and in a range (5 to 10 years) around LE. For most retail products using traditional funding, the IRR at life expectancy or joint life expectancy on a pre-tax basis is generally in a range of 3.5%-6%.

The risk component of permanent life insurance is the probability that the insurance will remain in-force until mortality. The type and magnitude of risk is dependent upon the type of policy used and its funding; at the most conservative, a policy with a premium-based contractual guarantee removes ambient market and interest rate risk – so long as premiums are paid in full and on-time, and if the issuing company is paying claims, a death benefit is paid. Conversely, the performance of a Variable Universal Life policy without a secondary guarantee is dependent upon the equity returns underlying the policy to generate and maintain the cash value to keep the policy in-force.

As we would expect, the anticipated IRR on a contract based on a fully guaranteed basis will be less than that of a policy with equity performance exposure. (It is beyond the scope of this article to discuss how various advanced funding or design options, such as premium finance, impact of loans or economic benefit of split dollar, etc., impact anticipated risk and return but one can infer that the greater the anticipated return, the greater the number and influence of risks.)

Life insurance is sometimes referred to as a “contingent” asset, since the triggering event for policy maturity (paying a death benefit) is contingent upon the death of the insured(s). Removing risk associated with the policy carrying to life expectancy, the difference between IRR’s is based upon the standard deviation of all annualized IRRs at various points (potential death years) – known as the “Sharpe Ratio.” Since the year-over-year IRRs and chances of mortality show very little variance around LE, the Sharpe Ratio for life insurance benefits form a notable low expected risk. This combination of predictable returns at predicable timing (NB: extreme outliers in timing tend to be premature deaths, which improve the return on investment … though not many clients seem to want that result) make the risk-return characteristics of properly structured and funded permanent life insurance a favorable stabilizer and improve the efficient frontier of a portfolio.

The Takeaways

Knowing with a high degree of confidence that the illustration isn’t an exact match to what will happen in the future, here are some key thinking points when analyzing an illustration:

Very few clients “need” life insurance. Individuals may be compelled to purchase life insurance as directed or required by contract or other legal binding agreement, such as a divorce, agreement of sale or buy-sell planning. Many of our clients, after careful analysis and evaluation, choose to use permanent life insurance as part of their asset allocation and wealth transfer strategy.
Policies implemented under a different exemption and/or for estates that are no longer subject to Federal estate tax can still be managed and positioned to end in a favorable result. This underlines the importance of routine inforce policy reviews to determine if there are ways to:
- Adjust the funding to ensure the policy remains inforce through life expectancy and is not unintentionally being overfunded.
- Determine if repositioning the cash value via a 1035 exchange to a new policy provides features – guaranteed death benefit, long-term care rider, elimination of future premiums – not available within the current contract.
- Before any changes are made, it is important to evaluate the insurability and current life expectancy of the insured.
  - Policies that may seem inferior to those available in the marketplace may be incredibly valuable if issued at a rate class/pricing more favorable than current insurability.
Positioning permanent life insurance as an asset class with unique characteristics allows for an evaluation of the use of insurance not as a need or protection solution, but instead as an allocation that provides diversification for legacy assets.

The past has shown us that predicting the future is very difficult to do, and therefore planning around “a number” creates an almost impossible task to accomplish. Whether it be drastically different tax and gift laws or significant, natural changes to a client’s overall taxable estate, strategies should be considered that would benefit the client independent of purely considering tax. While we don’t know what the exact answer will be, not doing anything may be the most damaging approach.

Michael C. DeFillipo, CLU, ChFC, is a Partner of 1847 Private Client Group, in Conshohocken, PA. Michael has nearly 20 years of experience working with high net worth and ultra-high net worth clients and their advisors designing, implementing and monitoring sophisticated life insurance portfolios. 1847 Private Client Group is an owner firm of Lion Street – an exclusive national network of elite financial firms.

[1] To be clear, this remains a question of opinion, and with the economic uncertainty surrounding us, it is unclear whether those opinions would be adjusted.

For education purposes only.

Registered Representative of, and Securities and Investment Advisory services offered through Honor, Townsend & Kent, LLC (“HTK”). Registered Investment Advisor, Member FINRA/SIPC. 600 Dresher Rd., Horsham, PA 19044, USA. 800-873-7637, www.htk.com. HTK is a wholly-owned subsidiary of The Penn Mutual Life Insurance Company. 1847Fianncial and 1847PCG is not affiliated with Honor, Townsend & Kent, LLC.

HTK does not offer tax or legal advice. Always consult a qualified adviser regarding your individual circumstances.

The Philadelphia Estate Planning Council is unaffiliated with HTK.

The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before implementing a strategy involving life insurance, it would be prudent to make sure you are insurable. As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges; if a policy is surrendered prematurely, there may be surrender charges and income tax implications. You should consult a qualified tax professional for tax advice on your own personal situation. All guarantees are based upon the claims-paying ability of the issuer.