3 Wealth Transfer Strategies Using RMDs - Part II: Eliminating Income Taxes

  • Originally published December 20, 2011 , last updated January 4, 2016
3 Wealth Transfer Strategies Using RMDs - Part II: Eliminating Income Taxes

The Baby Boomers over the next 20 years will transfer more wealth than this country has ever seen. Much of it, $7 trillion to be exact, is accumulating in tax-deferred accounts like IRAs and 401(k)s.

The key word here is tax-deferred, not tax free. No matter what you do, either you or your heirs will have to pay taxes on that money some day.

While these qualified assets are accumulating tax-deferred during your client’s lifetime, the tax burden they are leaving their children is growing as well. In this article series we're going to introduce three wealth transfer solutions specifically designed to alleviate the tax burden on qualified accounts like IRAs and 401(k)s.

Strategy No. 1 involved leveraging RMDs to Offset Income Taxes.

Wealth Transfer Strategy #2: Eliminating Income Taxes

Summary: Your client has a significant amount of money in an IRA. He is taking RMDs, but he doesn't need them for income. He would like to leave the IRA to his beneficiaries, but he's concerned about leaving them a large tax burden as well. In this concept, you take the unwanted RMDs and use them to fund a life insurance policy that will go to your beneficiary tax free. Then your client names a charity of his choice as the beneficiary of his IRA.

Assumptions:

  • Married couple
  • Both age 70
  • $1 million IRA in the husband's name
  • 6% growth rate on the IRA
  • 8% tax rate for the couple and their heirs
  • No withdrawals other than RMDs

Step 1: Determine the projected value of the IRA at a point in the future when your client expects to transfer the IRA value to his heirs.

There are varying degrees of detail you can go into here. You can purchase a life expectancy calculator that will take into account a variety of criteria to give the most accurate prediction. You can use a free calculator like the one at www.livingto100.com, which takes into account lifestyle factors, nutrition, body type and medical factors to give a life expectancy. Or you and your client can just select an age like 80, 85 or 90 for illustrative purposes.

In this case, let's say the client's life expectancy is 80. You will illustrate the IRA value at age 80 (taking into account the 6% growth rate and the RMDs) to be $1,154,424.

Step 2: Purchase a life insurance policy.

The client will use all or part of his RMDs to purchase a life insurance policy, naming a loved one as beneficiary, with a face amount equal to the projected value of the IRA at age 80: $1,154,424.

The death benefit will pass to the beneficiary income-tax free.

Your single clients might want to go with NACOLAH's Custom Guarantee, which offers the performance and flexibility of universal life insurance combined with the solid guarantees associated with whole life.

See an illustration for this case using Custom Guarantee.

Married couples might opt for NACOLAH's Survivorship GIUL, which would pay the death benefit to the designated beneficiary upon the second insured's death.

See an illustration for this case using Survivorship GIUL.

NACOLAH Custom Guarantee NACOLAH Survivorship GIUL
Year Age RMD Amount Premium Age Premium
1 70 $36,497 $39,549 70 $21,899
5 75 $47,857 $39,549 75 $21,899
10 80 $61,530 $39,549 80 $21,899
15 85 $76,866 $39,549 85 $21,899
20 90 $90,406 $39,549 90 $21,899
25 95 $95,482 $39,549 95 $21,899
30 100 $85,763 $39,549 100 $21,899

Step 3: Name a charity as beneficiary of the IRA.

Your client then names a charity of his choice as the beneficiary of the IRA. Charities are exempt from paying income taxes, so this essentially eliminates the tax obligation that would normally exist on the IRA.

By giving the IRA away as a charitable gift, your client could also reduce the overall value of his estate and consequently reduce any applicable estate taxes.

Result:

  • Beneficiary receives $1,154,424 tax-free death benefit
  • IRA transfers to the client's favorite charity, also tax-free
  • The client reduces the value of his overall estate
  • And the life insurance didn't cost your client anything "out-of-pocket" because he simply leveraged the RMDS hewas taking anyway. Rather than putting them in the bank, he simply committed a portion of them to paying his life insurance premiums

For more on NACOLAH Universal life insurance and how to leverage life insurance to reduce tax burden in wealth transfer situations, call your life marketer at 1-877-888-0166.