In the wake of an IRS ruling and the Supreme Court's repeal of a key provision of the Defense of Marriage Act, advisers are beginning to rethink the role of life insurance in same-sex couples' trust and estate plans.
Last week, the Internal Revenue Service and the Treasury Department issued Revenue Ruling 2013-17, which expands the terms “spouse” and “husband and wife” to include same-sex couples for federal tax purposes. That ruling applies only to couples who were married in a state that recognizes these unions, and excludes domestic partnerships and civil unions.
Prior to both rulings, life insurance was a primary source of estate planning and wealth enhancement for gay couples, as it was one of only a few ways to transfer property to a partner without being subjected to hefty estate taxes.
“Property passing to the [same-sex] spouses before didn't qualify for the marital deduction, so they were more likely to pay estate taxes,” said George D. Karibjanian, senior counsel at Proskauer Rose LLP. As a result, life insurance played a large role in establishing trusts to provide additional protection from these taxes.
The policies were also a way to create a stream of income from Social Security or a pension that was unavailable to same-sex spouses.
As a result, advisers are taking a second look at insurance these clients currently hold, and some plan to make this an agenda item when meeting with same-sex couples to review how the legislative updates will affect their plans.
“If the life insurance was being purchased to replace an income stream, is that still a valid necessity? Will it be there to take care of estate taxes?” asked Jill Hollander, an adviser with Financial Connections Group Inc. “You will still pay estate taxes, but how you calculate that tax will be different now.”
Along with an unlimited marital deduction, same-sex couples who are married also will be able to take advantage of the portability of the estate tax exemption, which is $5.25 million for an individual. Should one spouse die and still have leftover exclusion amounts, the surviving spouse can carry it over. That permits married couples to protect up to $10.5 million in wealth from estate taxes.
Still, it's not necessarily time to ditch the life insurance coverage, as the rulings are all new and same-sex couples could still face steep estate taxes if they end up in a state that doesn't recognize their marriage.
“I'd hate to say that there's no more need for life insurance based on what we've just heard; I want to see how everything shakes out and how the states respond,” said Debra Neiman, an adviser with Neiman & Associates Financial Services LLC. “They may not need life insurance for federal tax reasons, but they may need it for state-specific situations.”
When it comes to income planning, advisers may have less of a need for life insurance. Same-sex spouses are entitled to spousal benefits for Social Security, if they’re married and living in a state that recognizes the marriage, and retirement plans. “That lends itself to a lower income replacement need,” said Gavin Morrissey, senior vice president of wealth management at Commonwealth Financial Network.
Regardless of how clients opt to proceed on their insurance policies, it's probably a good time to go over the policy's provisions and to ensure that all of the paperwork needed to name a beneficiary is already completed. Given that states still differ vastly on recognizing same-sex marriages, clients can end up in a dispute if the spouses fail to designate a beneficiary to the policy and one of them dies while they live in a state that doesn't recognize the marriage.
“Say that you neglect to name the beneficiary for whatever reason, and now you rely on the policy provision, which might say that the default beneficiary is the spouse and the couple lives in a non-recognition state,” Mr. Karibjanian said. “Then you have a problem: Which laws govern the policy?” If the policy is covered by laws in a state that doesn't recognize the marriage and no beneficiary has been designated, the survivor may be unable to collect.
“The best practice is to get your benefits in place and make sure you've done everything you can do so that the proceeds go to the right party,” Mr. Karibjanian said. “This is an extra layer of review to avoid these problems.”