The value of each personal and dependent exemption will be $3,800, up $100 from 2011.  The new standard deduction is $11,900 for married couples filing a joint return, up $300.  For singles and married individuals filing separately, the standard deduction is now $5,950, up $150.  For heads of household, the deduction is up $200 to $8,700.

The $13,000 annual gift exclusion is unchanged, although the estate and gift lifetime exclusion for decedents dying during 2012 goes up from $5 million to $5.12 million.

The contribution limit for employees who participate in section 401(k), 403(b) or 457(b) plans and the federal government’s Thrift Savings Plan increases by $500 to $17,000. The catch-up contribution limit under those plans for those ages 50 and over is unchanged at $5,500.

New figures have also been established for many other items including the child tax credit, adoption assistance, medical savings accounts, American opportunity and lifetime learning credits, and the earned income credit—40 items in all.

For the official IRS notice,  click here.  Details on 401(k) and Profit-Sharing Plan Contribution Limits for 2012 can be found by clicking here.  403(b) contribution limits are outlined here and 457(b) limits are listed here.

This country’s debt crisis, as well as the embarrassing behavior exhibited by Congress during the last few weeks, is in large part, due to our government operating with mindsets, laws and traditions that are completely outdated. The U.S. Government is not addressing the needs of our country and its citizens; instead they are stuck in a 100 year old yoke.

 It’s Time for a Complete Overhaul 

This is a great country.  However, our government leaders have not taken a long, hard look at how the government, as an organization, is serving a constantly changing country.  A for-profit entity “re-tools” itself to stay efficient, effective and relevant.  It keeps what works and abandons what does not.  It stops throwing resources at things it should never have been doing or should no longer do.  Please don’t misunderstand; I am in no way speaking about the principles laid down by our Forefathers; they are unchangeable.  I am referring to the fact that the U.S. Government is operating with a tax code that is almost 100 years old. Our country has changed dramatically since Congress was given the right to impose a Federal income tax on February 3, 1913.  Any for- profit entity that existed in 1913 and did not drastically change how they operated over the last 100 years is no longer around. Why are we allowing our government to operate the same way it did 100 years ago?

A complete overhaul is needed; starting with the income tax system. A proposal has been made to abandon the Income Tax, as well as the IRS, and utilize the Fair Tax.  The Fair Tax is essentially a National Sales tax. I believe this proposal needs to be seriously considered and will be a great start to turning this country around.

How do you feel about the Fair Tax? If you don’t have enough information to respond, obtain a copy of “The Fair Tax Book” by Neal Boortz and John Linder. It’s an excellent read!

Much of the information available on whole life insurance is fabricated or, at best, anecdotal. From the advocates of A.L.Williams (Primerica Financial Services) who advise you to “buy term and invest the rest” to the pundits of talk radio who claim premiums are too expensive, whole life insurance has become the straw dog of what is wrong with financial services today—until recently.

 Whole Life Insurance

During the Great Depression, life insurance companies provided a much-needed source of cash for individuals, businesses, and even banks because these companies were considered to be very important to the business community. For example, from 1930–39, the Metropolitan Life Insurance Company provided life insurance benefits, including dividends, policy loans, and death benefits, in excess of $5 billion. This same financial strength recently surfaced during 2008 when, for example, the Massachusetts Mutual Life Insurance Company paid $1.38 billion in dividends, and the Northwestern Mutual Life Insurance Company paid $5.05 billion in dividends. If designed correctly, whole life insurance products may act as the cornerstone of a comprehensive financial plan. In addition to providing survivor benefits for risk management planning, whole life insurance also provides opportunities for asset protection; income tax planning; and other current economic benefits, including retirement supplement, emergency reserves, and college funding supplement.

Basic Design

Whole life insurance has a death benefit and cash value account. The purpose of the cash value account is to act as a reserve that offsets the death benefit paid to the beneficiaries. Life insurance companies also credit interest to the cash value account. When the life insurance contract matures, the cash value equals the promised death benefit that the contract will endow. Endowment is a taxable event for income tax purposes. The insured, at endowment, must report the difference between premiums paid and the contract cash value, which now equals the death benefit, as ordinary income. In order to keep the life insurance contract from endowing, insurance companies choose to allow the death benefit to continue, without further premium payments, when the insured reaches age 100. The Internal Revenue Code (IRC) provides favorable tax treatment for whole life insurance contracts. First, the proceeds of a whole life insurance policy maturing as a death benefit, subject to the exceptions stated in the law, are not subject to income tax when paid. Second, the growth of the cash values are tax deferred. Third, withdrawals from the cash value account are generally not taxable, as long as the amount withdrawn does not exceed the policy premiums paid to date. A whole life insurance contract, first and foremost, provides a death benefit. It is not an investment and should not be positioned as an investment. However, the cash values may provide several planning opportunities. Each time a premium is paid, a portion of the premium payment is deposited into a cash value account and accumulates tax deferred. The cash value account may be accessed at any time, subject to the contract’s delay clause. The cash may be used for a variety of needs, from education expenses and retirement income supplements to a source of capital for investments and business lines of credit. As a cautionary note, traditionally, whole life insurance contracts have little or no cash value in the first two years of the contract. This is the time in which the insurance company is recovering its acquisition costs and paying a commission to the insurance agent or broker. In an attempt to address this lack of liquidity, insurance companies developed the high early cash value (HECV) life insurance contract.

HECV

Many of these products were challenged by the IRS and deemed to be investments, so they were not afforded the favorable tax treatment given to whole life insurance contracts under the IRC. However, the Deficit Reduction Act (DEFRA) of 1984 added IRC Section 7702 that defined, for the first time, life insurance for federal income tax purposes. This definition provided insurance companies with the necessary guidelines to create HECV life insurance contracts. Many insurance companies offer an HECV product originally designed for businesses when high cash values in the early years of a life insurance contract were necessary for balance sheet accounting, nonqualified deferred compensation, or premium financing. Later, life insurance companies developed HECV products for individuals because the needs were similar, such as for emergency reserves, retirement supplements, and collateral for loans.

Term Insurance Riders

All of the major insurers now provide the option to purchase a term insurance rider on a whole life insurance contract. When purchasing a term life insurance rider, little or no commission is paid to the insurance agents or brokers from the contract premium. As a result, the cost of a term life insurance rider closely approximates the true cost of the insurance. The purpose of this rider is to supplement the death benefit of the underlying whole life insurance contract; the supplement is designed to satisfy a temporary need, such as an individual with a young family. Let’s say, for example, that the individual’s permanent need for life insurance is $2.5 million. However, the temporary need while the family is young and in peak earning years is $5 million. A $2.5 million term insurance rider is added to the underlying $2.5 million whole life insurance contract, bringing the total death benefit to $5 million.

Case Study

Planning Opportunity

Your client is a successful 33-year-old business owner who would like to protect his beneficiaries against the economic risk of his premature death and provide estate liquidity. The life insurance death benefit need is $5 million. In addition, he would like to protect his liquidity in the event of an investment opportunity. Asset protection is desirable, and a retirement supplement outside of his traditional qualified plans is a goal. The traditional whole life insurance contract for this client requires a premium of $49,600 per year and does not create cash value until contract year three. Several problems exist with this scenario. First, liquidity is severely drained because the cash value will be less than the premiums paid. Second, the amount of the premium is very high. Third, if a trust is made the owner of the life insurance contract, a sizeable taxable gift exists.

Planning Strategy

The planning strategy (Exhibit I) is initiated by creating an intentionally defective grantor trust (IDGT) that purchases an HECV whole life insurance contract with a term insurance rider. For the purpose of this article, the IDGT has the ability to purchase or transfer membership interests in various business entities owned by the client. This is a major advantage of using an IDGT versus a traditional irrevocable life insurance trust. The premium for the HECV whole life insurance contract with a term rider is $28,475, creating an annual savings of $21,125 per year. The client’s death benefit is $5 million, and the guaranteed cash value in the contract in year one is $25,625. As a result, approximately 89% of the premium paid is used to fund the cash value account. The client now has a portion of his emergency fund in the cash value account, accessible by the nongrantor spouse and creditor protected due to the use of the IDGT. The client also has removed a $5 million death benefit from his taxable estate.

The Bottom Line

Although whole life insurance has gotten bad press over the course of its existence, it has proven itself in the most challenging of economic environments. With the advent of IRC Section 7702, whole life insurance has become more flexible in its design and application. Given all of these advancements, CPA financial planners may want to revisit whole life insurance products as part of a comprehensive financial planning strategy for their clients.

Just got a letter in the mail that, effective 27 Jun 2011, “the company’s Target Date Funds will transition from mutual funds to collective trusts. The collective trusts will offer you the same investment strategy and risk, but the overall expenses will be lower – which is where participants save! As a result of this change the expense ratio will change.”

Exactly what’s changing here? How should I feel about this – Happy? Mad? Indifferent?

Great question!

You currently own a target date retirement fund. The target date retirement fund is a “hybrid” mutual fund which automatically resets its asset mix (stocks, bonds, cash equivalents) in its portfolio according to a selected time frame, e.g. a 2040 fund. Managers of target date funds typically use time horizon rather than risk tolerance or investment objective to determine the fund’s asset allocation. Typically, the further out the target date, the more the manager invests in stock. As the target date fund approaches its “target date,” the manager will reduce the percent invested in stock based upon a pre-determined “glide path” or allocation.

A collective trust is not a mutual fund. Collective trusts are pooled investment vehicles and unlike mutual funds, they may only be offered by a bank or a trust company. Additionally, collective trusts are only available to qualified plans (your 401(k)) and certain governmental plans used to supplement retirement. As such they are not available to retail investors.

Other items of note regarding collective trusts: a collective trust has a fiduciary structure (bank or a trust company), and by definition must rise to a higher administrative standard than a mutual fund; because the trust is not available to retail customers, their fees do tend to be lower than that of a mutual fund; a collective trust has the ability to invest in alternative or non-correlated asset classes.

My vote would be for happy.

Huzzah!

Tom