Insurance Q&A: Don’t Need Your IRA? Consider This Estate Planning Strategy


Richard T. Heffern, Director, Insurance Services

For those who do not need their IRA to support their lifetime spending needs, there is an interesting estate planning strategy utilizing life insurance that may be of interest.

Q: Rick, please briefly outline the concept of utilizing IRA distributions to acquire life insurance. How long has this concept been around and how can it help individuals and their beneficiaries maximize the after-tax value of an IRA in their estate?

A little background is appropriate to frame this. I think it’s safe to say many of us are attempting to maximize tax-deferred qualified plan vehicles through our working careers. These are fantastic tools that can transform savings and wealth via tax-advantaged compounding. However, we are finding that many of our clients who have accumulated significant IRA or qualified plan balances may not need all or, for that matter, any of those assets to support their lifestyle in retirement. This would typically be defined as a good problem to have If one is fortunate enough to be in this situation.

However, challenges emerge when thinking through how these assets will ultimately be passed along to family. Inherited traditional IRA and qualified plan balances are subject to income tax and are included in the taxable estate of the owner. Prior to the Secure Act of 2019, one would have had the ability to “stretch” the IRA balances out over the lifetimes of the heirs, and thus defer taxation over many years. Post 2019, these balances now must be paid out over a 10-year period. This not so slight rule change may have the unintended, or intended, consequence of increasing the value of a taxable estate and potentially pushing heirs into a higher tax bracket, which only compounds the problem. As a result, these assets become less than optimal as a tool to pass along dollars to family members.

Basically, life insurance is a tax-favored vehicle designed to provide liquidity at any point in time and, if paid to an irrevocable life insurance trust, the proceeds will be held outside of the taxable estate. Because of this, it is one of the most tax-efficient assets to pass along to family.

So, this idea combines the funding from the qualified plan balance with the tax-favored nature of the life insurance policy to create an interesting planning solution that transforms a tax-inefficient asset into a very tax-efficient asset.

Q: Who would this strategy be most appropriate for in your opinion and why?

This would be appropriate to consider for any individual over the age of 59 ½ that will not need all or a portion of their IRA or qualified plan balance to support their retirement income needs. Also important is the desire not to pay more in the way of taxes than necessary.

Q: For somebody who doesn’t need their IRA, why would this strategy potentially be better for after-tax estate maximization than taking and reinvesting the distributions in the more traditional way?

We are, in effect, doing just that. Taking distributions the same way and then just deploying a portion into an estate planning structure and product that can create a tax-free benefit. 

Q: What is the main risk or push back you hear about this strategy versus the traditional approach of taking and reinvesting IRA distributions in taxable investments? 

The main push back is whether a client might still need these assets to support their lifestyle in retirement. Once that issue is discussed and confirmed with their financial plan, we find little resistance in further evaluation and ultimate implementation.

Q: The current taxable estate exemption of roughly $12 million per individual or $24 million per married couple is set to sunset in 2025 with projections that it would move lower to around $6 million per individual and $12 million per married couple, how does this strategy play into that scenario?

This concept can assist in reducing the overall taxable estate by shifting a portion of the IRA from being a heavily taxable asset to a tax-free asset once the dollars are in the policy and it is held in a trust outside the taxable estate.

Q: If someone’s interested in exploring this option, what’s their first step?

I would say reach out to your relationship manager or financial planner. We can quickly evaluate the specifics and know whether the concept provides an interesting solution for you and your family.

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