ObamaCare’s Tax Consequences on Investments

(The following are my observations, interpretations and opinions and should not be construed as specific tax, investment, legal or insurance advice.  Furthermore, the referenced information is subject to change)

According to a Wall Street Journal “SmartMoney” article I read today on the tax consequences of ObamaCare (click here) and a Wikipedia article on capital gains (click here), if I understand these articles correctly, the expiring Bush tax cuts and the new ObamaCare (otherwise known as the Affordable Care Act that was just approved by the Supreme Court) will result in the following tax changes on taxable and tax-deferred investments starting in 2013:

  • Long-term capital gains
    • Low-income earners paying 0% now will pay 10%
    • Those paying 15% now will pay 20%
    • High-income earners paying 15% now will pay 23.8% (including the new “Medicare contribution tax”)
  • Short-term capital gains and dividends
    • Those in the 10% bracket now will pay 15%
    • Those in the 15% bracket now will stay at 15%
    • Those in the 25% bracket now will pay 28%
    • Those in the 28% bracket now will pay 31%
    • Those in the 33% bracket now will pay 36%-39.8% (some will pay the new “Medicare contribution tax”)
    • Those in the 35% bracket now will pay 43.4% (including the new “Medicare contribution tax”)

This is bad news for those with taxable or tax-deferred assets, but it is good news for income-tax-free assets like Roth retirement accounts and cash value life insurance, since the tax-equivalent net return (IRR) will increase significantly for these income-tax-free assets (note: I have not read anywhere that taxes on Roth retirement accounts or cash value life insurance will change under ObamaCare).

Presently, an income-tax-free cash value life insurance contract with a lifetime cash value IRR of 8% would require an alternative taxable asset to earn a lifetime average return of 12.31% to break even with a 35% tax bracket.  Starting in 2013, this same taxable asset would have to earn a lifetime average return of 14.13% to break even with a 43.4% tax bracket.

To take the analysis further, if we assume state income taxes of 5%, annual advisory fees of 1% and annual fund fees of ½ %, then a taxable mutual fund (with a high turnover ratio) would require a lifetime average return of about 16% (if we allow for tax deduction of advisory and fund fees) to break even on an income-tax-free life insurance contract with an 8% cash value IRR.  In essence, the mutual fund would have to earn about DOUBLE that of an income-tax-free life insurance contract—and that does not even include the value of the contract’s death benefit during the insured’s lifetime (note: the mortality costs of the death benefit has already been considered in the cash value’s net IRR calculation).  Importantly, from a risk perspective, the mutual fund would be exposed to market losses, while the appropriate cash value life insurance contract would not be exposed to market losses.

Additionally, since many lending institutions allow life insurance to be financed (leveraged) with favorable lending terms (unlike mutual funds and retirement plans), the new tax-equivalent leveraged IRR of financed life insurance will also see an increase starting in 2013—making leveraged life insurance even more attractive for the appropriate investor.

All in all, when we consider the liquidity, safety, low expense, rate of return potential and tax efficiency of a properly-structured, properly-funded and properly-utilized cash value life insurance contract, we can see why this asset could be considered an integral component of an investor’s portfolio.

As an aside, the expiring Bush tax cuts and the new ObamaCare tax changes are also good news for financial strategies that PERMANENTLY reduce taxable earned income, since federal income tax brackets will be as high as 39.6% and Medicare will be as high as 3.8% (an increase of 31% over the current 2.9%).  For example, a person could potentially realize a total tax savings as high as 43.4% for each dollar of taxable earned income reduced by the appropriate strategy (not counting state income tax savings that may result as well).

Finally, if a family desires to own life insurance outside of their estate (for estate tax and/or asset protection purposes), they should be aware they are currently allowed to gift up to $10,240,000 (per couple) into appropriate trusts for both gift tax and generation-skipping transfer tax exclusions.  However, as of 2013, these exclusions get reduced $8,240,000—down to $2,000,000 (per couple).

Bottom line?  The expiring Bush tax cuts and the new ObamaCare both provide strong incentives for appropriate life insurance planning—starting now.

These incentives present opportunities for business planning, investment planning, retirement planning, estate planning and charitable planning.

Feel free to contact me to discuss these opportunities further,

Michael D. Morrow, CLU, ChFC


(817) 881-0591

© 2012

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