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3 Wealth Transfer Strategies Using RMDs - Part I: Offsetting 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. 2: Eliminating Income Taxes

Strategy No. 3: Creating Multi-Generational Wealth

Wealth Transfer Strategy #1: Offsetting 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 a portion of the unwanted RMDs and use them to fund a life insurance policy that will help offset the income taxes his beneficiaries will owe when the IRA is transferred to them.

Assumptions:

  • Married couple

  • Both age 70

  • $1 million IRA in the husband’s name

  • 6% growth rate on the IRA

  • 28% 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: Estimate the income tax the beneficiary will owe if the IRA is inherited as a lump sum when your client turns 80.
 
If your beneficiary inherits the IRA as a lump sum, income taxes will be assessed on the entire amount. To figure out the taxes they’ll owe, just take the estimated value of the annuity at the time of transfer and multiply it by the beneficiary’s income tax rate.
 
Estimated Value (age 80)
 
Estimated Tax Rate
 
Taxes owed by beneficiary
$1,154,424
X
28%
=
$323,239
 
Step 3: Purchase life insurance.
 
Use a portion of the client’s unwanted RMDs to fund a life insurance policy with a face amount equal to the beneficiary’s expected tax liability—in this case $323,239.
 
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 and illustration for this case using Survivorship GIUL.
 
 
Result:
  • Beneficiary receives $1,154,424 inheritance from the IRA.
  • Beneficiary receives $323,239 life insurance death benefit, which is used to pay the tax liability owed on the IRA. 
  • The asset transfers, essentially, with no tax liability for the beneficiary.
  • And the life insurance didn’t cost your client anything “out-of-pocket” because he simply leveraged the RMDS he was 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 how to leverage life insurance to reduce tax burden in wealth transfer situations, call Pat Sheridan at 1-800-786-5566 ext. 3627.

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