By Matt Kaas, Life Marketing Consultant
When it comes to preparing for retirement, many individuals have a financial strategy that includes some sort of qualified plan such as a 401(k) or a traditional individual retirement account (IRA). These tax-incented retirement vehicles typically accumulate on a tax-deferred basis, and distributions are generally taxed as ordinary income. These retirement vehicles often have other restrictions such as a 10% penalty on distributions before 59½ years of age, as well as required minimum distributions (RMDs). RMDs require the client, upon reaching age 70½, to take distributions from qualified accounts in accordance with minimum distribution requirements established by IRS regulations.
Now for most retirees, RMD requirements are not a concern, as they will use these distributions as retirement income. But what about those retirees who already have their income needs met from other sources and do not need their RMD? For these clients RMDs can actually create a headache, requiring the client to pay ordinary income tax on RMDs, and in some instances increasing the tax bracket the client falls into. These clients, who do not need their RMDs for income to live off of, typically end up earmarking this money for their beneficiaries and stockpiling it away either in a bank or some other non-qualified financial vehicle. But is there a better option for these RMDs?
Considering current income is not needed, should these clients qualify for underwriting, they may be able to use their RMDs to purchase a life insurance policy to take advantage of the income-tax free death benefit, therefore passing funds to a beneficiary in a more tax-favorable way. This comes with the potential for the income-tax-free death benefit being greater than what the accumulated RMDs would have been. This may then allow the beneficiaries to offset tax liability from other inherited funds.
Let’s take a look at an example. Mary is 71 years old, and has a $1 million traditional IRA that she does not need income from to live on, nor does she expect to access it as her emergency fund. Her RMD in the first year will be $36,496, and after paying income tax on that amount (assuming a 25% marginal income tax bracket) she would have approximately $27,000.
While the cost of insurance and the death benefit will vary based on the product type, carrier, and underwriting information, this concept may work with several different types of cash value life insurance products. For the sake of this example, I’ve focused on using guaranteed universal life (GUL) insurance. GUL’s primary considerations include a guaranteed level insurance premium, and a guaranteed level death benefit.*
Assuming Mary qualifies for a standard non-nicotine underwriting classification, she could purchase approximately $900,000 of face amount life insurance policy with a $27,000 annual premium. If we assume a life expectancy of 90, Mary would have paid $513,000 in premiums and her beneficiaries could stand to receive $900,000 income-tax-free, in the form of a death benefit. Therefore, not only does this create the option to pass on a larger amount of assets to beneficiaries, but it also helps to increase the tax efficiency with which those assets are passed on.
Too many times have I heard, “my clients are older, they do not need life insurance.” Hopefully this article has shown you a reason that you can look to life insurance for older clients where appropriate, that could really make a difference to their beneficiaries. For more information on using RMDs to purchase a life insurance policy, or for more strategies on how life insurance may benefit many of your clients – even your older ones – please give me a call at 800.321.3924 x133.
Matt Kaas | Life Marketing Consultant
Ann Arbor Annuity Exchange
Ph: 800.321.3924 x133 | Dir: 734.786.6133
* Guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company.
This article is designed to provide general information on the subjects covered. It is not, however, intended to provide specific legal or tax advice and cannot be used to avoid tax penalties or to promote, market, or recommend any tax plan or arrangement. Please note that Ann Arbor Annuity Exchange and its representatives do not give legal or tax advice. Encourage your clients to consult their tax advisor or attorney.
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