Advanced Markets

Maybe there’s some favorable news for insurance agents and brokers, but don’t jump too high!

Recall that the Tax Cuts and Jobs Act of 2017 (TCJA) lowered the highest tax rate on C-corporations to 21%. To afford at least a partially similar benefit to pass-through businesses (S-corporations, partnerships, and sole proprietorships, or any LLC taxed as one of those three), a business deduction was possible that could be applied to the owner’s individual taxable income.

This “Section 199A Deduction” could be up to 20% of a business’s qualified business income

(QBI – the definition is unimportant for purposes of this article).  The deduction was subject to a phase-out or reduction, and TCJA divided all pass-through businesses into two categories for purposes of determining the amount of this “deduction reduction.”

The first was Specified Service Businesses. An owner of a Specified Service Business is eligible for a full 20% deduction if his or her personal taxable income is below $157,500 ($315,000 if filing jointly).  As taxable income increases the size of the deduction is reduced until the owner’s taxable income reaches $207,500 ($415,000 if filing jointly).  After that there is no deduction available.

The same taxable income level breakpoints are applied to businesses in the second category, Non-service Businesses, but their owners have an advantage in that the deduction phases out less or not at all if (in a nutshell) the company has a sizeable multi-employee wage base, or the owner has significant basis in the business.

The brou-ha-ha within the insurance industry when TCJA was passed was whether or not insurance agents and insurance brokers fell into the more advantageous second category (Non-service Businesses).

The legislation was unclear.

But now the U.S. Treasury has issued final regulations for TCJA that would include in the second (again, the more favorable) category of Non-service Businesses all insurance agents, agencies and brokerages taxed as a pass-through.  But the circumspect insurance advisor has reason to pause.

One group that the TCJA definitely specifies as a Specified Service Business are companies involved in “financial services”

These services are defined (in part) as the provision of financial services including “managing wealth, advising clients with respect to finances, developing retirement plans, developing wealth transitions plans . . .”, etc. (emphasis added).

It is hard to imagine comprehensive insurance planning that does not wander over into these regions.  Consult with your tax advisor for a final conclusion.

The good news for small insurance enterprises is that, business category notwithstanding; taxpayers with taxable income under $157,500 ($315,000 if filing jointly) are still eligible for the full 20% reduction and eligible for some relief at higher taxable income levels.

An excellent discussion from Principal Financial of the Section 199A Deduction under TCJA and the Regulations is available HERE.

Nobody gets help with college costs nowadays unless they first fill out a lengthy and bothersome form known as the FAFSA (the acronym stands for Free Application for Federal Student Aid, just in case it ever pops up when you choose the Governmental Financial Assistance category on Double Jeopardy).

The information entered therein drives all consideration for aid under all Federal and many State educational programs.

Now here’s the rub

FAFSA has certain eligibility criteria that determines – based on your income and net worth – how much you should be contributing to your child’s higher education.

If the amount they determine you can pay is too high it renders you ineligible for assistance.

And therein lies the additional rub

If you are poor and haven’t paid much of the tax that supports the assistance programs, then you’ll probably get financial support.  If you are rich and paid a great deal of the tax to fund the programs, then you probably won’t get any aid – but no big deal because you’ve got enough to pay the piper anyway.

The people that get hammered are those in the middle who have paid their fair share of the tax and, in addition, have been responsible enough to save, invest, and accumulate against the day of their anticipated retirement – only to find that the net worth that their sound economic behavior has created disqualifies them for assistance.

Here is where you can help your clients

Especially those with liquid net worth considerable enough that is proscribes or prohibits assistance.

The instructions for completion of the FAFSA form direct that in reporting financial information, “Net worth means current value [of includible assets] minus debt.”  For example, a commercial building worth $300,000 with a $100,000 mortgage would add $200,000 to the net worth calculation.

But more important – when adding the value of investments the instructions state that “Investments do not include . . . the value of life insurance . . . [or] annuities . . .”

How many clients do you have with considerable amounts of net worth in low-performing assets like CDs?  And now the value of those assets are creating a roadblock to financial add.

One simple solution to recommend is the transfer of funds to an annuity contract or an overfunded life insurance policy (they may not have adequate coverage anyway).

The timing of a purchase doesn’t appear to be an issue

In researching this strategy, calls to the FAFSA information line drew the response that an annuity or life policy was exempt so long as it was in force at the time of the completion of the FAFSA application.  Needless to say, a client should do his or her own spadework in this regard before making a decision.

Once the child is graduated or no longer in need of assistance, funds can be transferred back into the investment opportunities of choice.  From the time that inquiries into possible financial aid begin until the event of a child’s graduation is usually long enough to purchase an annuity with an acceptably short surrender charge period – especially if the 10 o’clock scholar involved is one inclined to pack four years of higher education into six.

Contact us for the best product opportunities available for clients who are prospects for this FAFSA Net Worth Minimization Strategy.

An earlier article discussed Opportunity Recognition, one of the Four Cornerstones of building a successful charitable planning practice. Recall the reference to fundamental testamentary transfers – bequests by will.

These transfers take place only upon the death of the donor and bequests by Will represent the largest segment of testamentary transfers that occur. But there are others worthy of your familiarity as you progress in your ability to uncover gifts.

First, are beneficiary designations

These can be attached to annuities, life insurance policies and even qualified plan accounts such as IRAs or 401k plans.

Remember that opportunity recognition is a process of discovery, so take time to read every document and ask a lot of questions.

For example, when you see a charitable designation for a life insurance policy, find if it may be best to gift the policy now and utilize the immediate income tax deduction that will result. And if you do accelerate the gift check with the charity, make certain that their policy allows gifts of life insurance.

You will be shocked how many organizations either don’t have a written gift acceptance policy or won’t accept any asset other than cash or readily marketable securities. You may conclude that it is better to give a different asset because the life insurance will go to the non-charitable beneficiaries income tax-free while other assets, such as IRAs, may not.

If a charity is the designated beneficiary on an IRA or other qualified plans, again, it’s time to ask questions that help you clearly understand the philanthropic intent of your client and donor. Does your client know that the beneficiary designation can be split among multiple charities in any percentage?

Now that the charitable IRA rollover is a permanent part of the tax law, it might be appropriate to help your client take advantage of the 100k per year direct IRA gift. Advisors can be a huge help in sorting through the somewhat complex forms and paperwork that often accompany this particular gift.

Less common, but still an important type of account is the Transfer on Death or TOD account

These operate a beneficiary designation only for assets that are not normally associated with having “beneficiaries,” such as bank accounts, brokerage accounts, and even real estate. When real estate is involved, it is that state’s regulations that govern transfers.

Currently, approximately eighteen states allow TODs of real estate – a few more have introduced legislation. If this is something that you were thinking about recommending, check state law first. TODs can be established to transfer to heirs, to charities or both.

However, if you spot an existing TOD headed for charity, this is a great opportunity to discuss other charitable options for the same asset(s). Appreciated securities may be exchanged for a charitable gift annuity, contributed to a charitable remainder trust or even a new pooled income fund.

Active pursuit of this kind of examination by advisors should be common!

This activity alone will set you apart from your peers. But what will distinguish you is the ability to unlock gifts that your clients were unaware they could create. You can find hidden treasure simply by reading documents and looking at beneficiary designations, then asking good questions about what you discover. This is an extraordinary opportunity for your clients and for you as an advisor.

Robots have rules to live by; or so we were first told by author Isaac Asimov in his 1942 science fiction short story, Runaround.

His Three Laws of Robotics dictated:  1) A robot may not injure a human or allow a human to come to harm.  2) A robot must obey the orders given it by humans except where such orders would conflict with the First Law.  3) A robot must protect its own existence as long it does not conflict with the First or Second Laws.

If only all things in life were attended by such an uncomplicated litany to guide behavior.

In two articles we have addressed the brouhaha surrounding the future of the federal estate, gift and generation-skipping transfer tax laws under the  new administration, including discussions on the likelihood of repeal and what might be left in their place if repeal was accomplished.

The heart of matter for insurance advisors is the effects any changes will have on the volume of large-case sales where coverage is purchased to pay unavoidable anticipated death taxes.

And the good news is that not much changes if “anticipated” means what might be expected rather than simply the levy under the current loi du jour within the Internal Revenue Code.

Consider our suggestions for rules by which to conduct your business in the unchanged fluidity of the laws by which we must attempt to help clients best plan for their financial affairs.

The Six Semi-Unassailable Principles Of Life Insurance In A Changing Tax Environment:

1. The Rule of Law is gone.  Nothing is permanent.  Don’t ever plan for a client based on the current tax law, but rather on the worst that might be anticipated.
2. Chances are a client’s insurability will not improve with time.
3. Chances are that many of the current favorable product designs for policies will be unavailable with time.
4. Chances are the cost of coverage will increase with time.
5. In view of Principals, ##1-4 existing coverage held for anticipated death tax liability should not be surrendered because of current favorable tax law changes.
6. In view of Principals ##1-4 the purchase of coverage to pay death taxes should not be postponed because of a current favorable change in the tax law.

The story goes that a hopping-mad Asimov came out of his first viewing of the film 2001: A Space Odyssey in which the mainframe computer, HAL, did away with one of the space station’s astronauts. To the surrounding crowd in the theater lobby he excoriated the film’s director, Stanley Kubrick, saying, “He broke the first rule!  He broke the first rule!”  One bystander replied, “Why don’t you just strike him dead, Isaac?”

Contact us for a brand-able and free two-page summary of the possibilities regarding changes in the tax law that would be helpful in your discussions with concerned clients.