Life insurance planning for wealthy Americans may be upended by a proposal in Democrats’ tax reform package.

The House Ways and Means Committee passed measures on Sept. 15 that would raise an estimated $2.1 trillion in taxes from corporations and the rich, to help finance President Joe Biden’s economic agenda.

One rule would curb a type of trust (a grantor trust) the affluent use to shield their estates from tax at death and pass more money to heirs.

If passed, the rule may change how those with multimillion-dollar estates buy life insurance. They often hold their life insurance policy in trusts targeted by the House proposal — which, if it becomes law, may trigger a big estate-tax bill down the road, according to experts.

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“I think most life-insurance trusts would be hit by this proposal,” said Beth Shapiro Kaufman, an estate planner at law firm Caplin & Drysdale.

A life-insurance trust acts as an intermediary — it funnels the insurance payout to beneficiaries, such as a spouse or kids, upon the buyer’s death.

These trusts can also yield tax savings. They remove the insurance benefit from one’s taxable estate at death.

For low- and middle-earners, this sort of planning isn’t typically a concern. Estates only owe tax (a 40% federal rate) if their cumulative property exceeds $11.7 million in value, or double for married couples.

But for the wealthy, the financial benefit of life-insurance trusts can be big.

Here’s a simple example: An individual dies with $10 million of real estate and investment accounts, and $3 million of life insurance. The person’s estate would owe $520,000 of federal tax (or, 40% of the value over $11.7 million) if the policy weren’t in a trust; it wouldn’t owe any tax if held in trust.

These trusts are often grantor trusts, according to estate planners. This mechanism allows buyers to make payments to the trust each year to cover annual insurance premiums, they said.

However, the House tax proposal and current estate rules are such that, if the legislation succeeds, life insurance in a grantor trust would become part of one’s taxable estate at death, negating the aforementioned tax benefits, according to David Herzig, a tax principal with Ernst & Young.

(The legislation would also reduce the estate-tax asset threshold to $5 million per person, meaning a bigger share of existing taxpayers’ estates would be subject to tax. )

Of course, the proposal isn’t final. Democrats haven’t yet reached consensus on the overall package amid disagreements over its contents and scope. The grantor-trust provision may be omitted or amended in a tax package issued by Senate Democrats.

Some planners think there’d be ways around the rule even if it becomes final.

“It’s a solvable problem,” said Robert Lord, counsel for Americans for Tax Fairness, a progressive group.

For example, the wealthy may be able to modify their trusts to escape the House rules, he said.

Others are skeptical of the ease with which that can be accomplished. For example, doing so might mean the wealthy can no longer make annual contributions to pay the insurance premiums or risk triggering tax.

“There is an esoteric question of, could you actually create the trust?” Herzig said. “At best, it’s uncertain at this point.”