Plan for Scheduled 2026 Tax Law Changes with Life Insurance

The current and historically high federal gift and estate tax exclusion and the corresponding exemption from generation-skipping transfer tax (GSTT), sometimes individually or collectively referred to as transfer tax(es), ¹ may prove to be a once-in-a-lifetime opportunity to tax-efficiently pass significant wealth to children, grandchildren, and more distant generations. Using life insurance in your wealth transfer plan can potentially increase the amount passing to your family members and boost tax efficiency. ²

Time May Be Running Out

The Tax Cuts and Jobs Act of 2017 (TCJA) ³ ) effectively doubled the gift and estate tax exclusion and the GSTT exemption from the limits in effect prior to its passage in 2017. The exclusion amounts for 2025 are $13.99 million per person,⁴ or $27.98 million for a married couple).

The increased exclusion amounts, however, are not permanent. Assuming no changes to the law, the current exclusion amount (as further adjusted for inflation) is set to expire on December 31, 2025.⁵ Beginning January 1, 2026, the exclusion amount will be decreased to $5 million, indexed for inflation. Although the exclusion amount in 2026 had been projected to be approximately $6.4 million,⁶ elevated inflation may cause that figure to increase. And while an estate plan should not be based solely on potential taxation, consideration should be given to using the currently high exclusion amount while it remains available.

“There may be no better time than now to plan a major financial gift to someone you love,” said Darcy Roennfeldt, head of Fiduciary Services at PNC Private Bank Hawthorn. “With the current exclusions expiring at the beginning of next year, there’s still time to gift significant wealth with limited tax impacts.”

Using the increased exclusion amount to incorporate or support a life insurance strategy in your estate plan could be a great way to leverage your exclusion amounts, without jeopardizing other planning goals. Of course, each family has unique goals, so a plan that works for one family may not be appropriate for another. Nevertheless, following are some ideas to consider with your advisory team.

Life Insurance, Generally

In general, there are two major categories of life insurance.

Term Insurance

Term insurance provides a death benefit should the insured die during a specific period of time, or term. Some policies of term insurance can be continued after the term, but at an increased premium cost. Additionally, some term insurance policies can be converted to permanent policies at the then-cost of permanent insurance based upon the insured’s age but without the need for additional underwriting. 

“Permanent” Insurance

Permanent insurance is inclusive of many different types of policies, such as whole life insurance, variable life insurance, universal life insurance and index life insurance. Each policy type has specific attributes and benefits, which can vary widely from policy to policy. Often, a policy of permanent insurance will build cash value, which may be necessary to support the policy’s death benefit, especially in the policy’s later years. Generally, the cash value that builds up inside a life insurance policy is the cumulative amount of the premiums paid by the owner of the policy, plus return on investment, less the costs to maintain the policy. The policy owner may access this cash value during the insured’s life. However, depleting the cash value could cause policy guarantees, or the insurance coverage itself, to lapse and potentially cause an income tax event.

The Advantages of Life Insurance

 

Life insurance is purchased for many reasons. For many, a policy death benefit can replace wages lost when a working spouse dies, pay off a mortgage so that a surviving spouse can continue living in the family residence, or pay the expenses of dependent children if one or both parents die. For a family of substantial wealth, a policy death benefit could be used to pay estate or inheritance tax, provide liquidity to prevent a forced sale of assets or equalize the value of transfers among beneficiaries. Whatever its use, a life insurance death benefit is a way to augment the amount of wealth passing to your beneficiaries⁷.

“Life insurance is a versatile product that, in addition to providing a benefit upon death, also has value during the insured’s life,” said Tristan Harding, director of Client Risk Management Strategy at PNC Private Bank Hawthorn. “Still, life insurance can be a particularly effective method of transferring wealth due to its potential tax efficiencies.”

Consider life insurance’s efficiencies relative to the following:

Income Tax.

Certain permanent policies of life insurance can accumulate cash value. Some permanent policies allow the owner of the policy to invest the policy’s cash value. Value that accumulates inside a life insurance policy is not subject to income tax.⁸ This may allow the investments inside the policy to grow more quickly than investments that are subject to income tax.

Unless certain exceptions apply, the death benefit from a life insurance policy is not subject to federal income tax⁹. Some permanent policies add the policy’s cash value to the death benefit. In that case, following the death of the insured, the beneficiaries of the policy will receive the stated death benefit plus the value of the policy’s investments income tax-free.

Federal Estate Tax and GSTT.

If certain criteria are met, it is possible for beneficiaries to receive a tax-free cash benefit following the death of the insured. If the policy is owned by an irrevocable life insurance trust (ILIT) ¹⁰, a financial advisor can also help you leverage your GSTT ¹¹ exemption.

Using the Exclusion Amount with Life Insurance

To keep a life insurance policy in effect, the owner must pay premiums to the insurance company that issued the policy. Someone other than the insured should own the policy, however, to avoid being subject to federal estate tax. ¹² An ILIT can be an effective choice to serve as owner as the benefit can extend beyond just the insured’s family. 

ILITs can be designed so that cash transferred to the trust for purposes of paying a policy premium can qualify for the annual exclusion from gift tax.¹³ It’s important to talk to your advisor about how to: properly gift funds to the trust to maximize tax efficiency; ensure that the trust is able to maintain a policy large enough to support any beneficiaries; and not hinder any additional planned gifts that could be subject to gift tax. Your advisor can also provide clarity on how to structure an ILIT to support a larger policy whose premiums exceed the lifetime exclusion amount. 

Like any financial asset, you should review your life insurance policies regularly to see if they are performing as expected. If your policy has underperformed and it is possible that its cash value will run out, you may be able to exchange the underperforming life insurance policy for a new one (with better contract provisions) in a tax-free exchange.¹⁴ If, due to age or health you are unable to purchase a new policy, you may be able to preserve the existing policy with a cash infusion. Your advisor can help structure any necessary cash gift to the policy and plan for any gift tax liability that may result.

“It’s important to structure your policy in a way that couples tax-efficiency with long-term sustainability,” Harding said. “Engaging your advisor early and often in your estate plan that involves life insurance is critical.” .

A similar approach could be used to protect against the early death of a non-charitable beneficiary of a charitable remainder trust (CRT). ¹⁵ Higher interest rates make CRT planning more effective. There are many reasons to create a CRT. One reason to do so, is to spread income tax liability out over the non-charitable beneficiary’s lifetime. People who wish to benefit charity while deferring tax often use a CRT. For example, a CRT can be used as the beneficiary of a qualified retirement plan or IRA or to diversify an appreciated concentrated position. ¹⁶ However, should the non-charitable beneficiary die prematurely, the beneficiary’s family will not receive the benefit of a long stream of payments, as the death of the beneficiary would cause any property in the CRT to be paid to the charitable beneficiaries. To protect the beneficiary’s family from losing wealth intended to be received from a long-term stream of payments, the non-charitable beneficiary could fund an ILIT using some or all of the non-charitable beneficiary’s exclusion amount.

Helping Others Plan

Purchasing and planning for life insurance can extend beyond policies that benefit the individual. Insurance premiums are lower for younger and healthier people and as we age, there comes a time when purchasing a policy of life insurance on our own lives becomes prohibitively expensive or entirely unavailable. But even if you cannot purchase a policy of insurance on your own life, perhaps you can help your children or grandchildren purchase insurance.

Senior members of the family can use their exclusion amount to fund a trust that benefits their child’s descendants. The trustee can leverage the gift by investing some (or all) of the gift in a policy of life insurance to insure a child’s life. Upon the child’s death, the death benefit would be available for the donor’s grandchildren. It’s important, though, to consider how property transferred to the trust can cause future GSTT tax liability.  Nevertheless, if done right, a senior family member can help provide financial security for their grandchildren and more distant descendants. ¹⁷

Tax-Free Investing

As stated above, cash value accumulates inside a life insurance policy without reduction for income tax, and if paid as part of the death benefit that cash value escapes income tax altogether. Furthermore, if the policy is owned in a properly constructed and administered ILIT, the death benefit (and any cash value included in the death benefit) will not be subject to the estate tax. 

Usually, owners of life insurance policies look to buy the greatest amount of death benefit for the least premium cost. That may not be the most effective strategy however as there is a maximum amount that can be paid into a life insurance policy without triggering certain adverse income tax consequences.¹⁸ Consider instead what could happen if a policy owner contributed the maximum amount possible to a policy, while purchasing the least amount of death benefit necessary to support the premiums paid: The owner of the policy would have an investment fund that would grow without income tax and upon death would pay a cash death benefit plus the value of the accumulated policy investments without reduction for income or estate tax. This type of arrangement can be constructed through a private placement life insurance policy by creating a trust that distributes the proceeds of the policy tax-advantaged upon your death.

 

Don’t Go It Alone

Estate and financial planning is a complicated process that can impact the financial future of multiple generations.  When considering life insurance solutions as part of your plan it’s important to consult legal, tax and financial advisors to help you achieve your personal and financial goals.

“When structured correctly, there are few instruments as effective as life insurance to provide financial security for your family’s future,” Roennfeldt said. “And now may be the right time to consider how you can gift it in a tax-efficient way.”