By Mike Martinez, CLU, ChFC, Director, Doeren Mayhew Insurance Group

Many successful high-net-worth individuals reach retirement with sufficient assets to live their desired lifestyle, but oftentimes their biggest concern and planning challenge is determining the most tax efficient way to pass those assets to the next generation and beyond (i.e. charities). One alternative to consider is an Individual Retirement Account (IRA) Maximization via life insurance — a strategy designed to help retirees reposition their assets into a more favorable tax-savings vehicle.

How it Works

Assets held in tax-deferred qualified plans are inefficient and subject to income tax with respect to a decedent (IRD) and includable in the taxable estate for estate tax purposes. Therefore, it makes sense to transfer those assets into a more tax efficient instrument.

In many cases, high-net-worth retirees will begin to withdraw taxable distributions at age 72 (previously age 70.5) from their traditional IRA, 401(k) etc., that they don’t really need or want. The end result is that those after-tax distributions just get added to their other investable assets, which in turn increases their taxable estate. A more proactive strategy for managing these forced distributions could reduce or even eliminate both the IRD and potential estate tax burden while simultaneously increasing the amount of wealth transferred to their heirs and charities.

Here’s how you can maximize your tax savings using life insurance:

  • The qualified plan owner establishes an individual life insurance trust (ILIT). The ILIT applies for a life insurance policy on the owner’s life (or a joint-life policy on the plan owner and spouse).
  • The owner begins annual distributions from the plan to fund the life insurance and has one of two options:
    1. Invest the IRA assets designated for repositioning in a single­ premium immediate annuity (SPIA), which provides a lifetime income for the client. With an SPIA, there are no market fluctuation risks to contend with. The income is 100% guaranteed, so the owner cannot outlive the income and the value includable in the taxable estate at death is zero.
    2. Take annual early taxable distributions if the owner is between the ages of 60-72, or take RMDs if over the age of 72.

In either case, the after-tax distribution proceeds are gifted to the ILIT to fund the life insurance policy. Upon the insured’s death (or death of the survivor if both spouses are insured), the death benefit will be paid to the trust for distribution to the heirs without being subject to income or estate taxes.

One caveat to consider is that individuals who take advantage of this tax-savings method must be sure that they will not need that portion of their retirement plan for retirement income.

Doeren Mayhew Insurance Group works closely with individuals to identify life insurance policies that offer tax-efficient solutions. To learn more about how to use life insurance to your tax advantage, contact us today.