Creating a Legacy by Maximizing IRA Assets

Many high-net-worth individuals will be transferring wealth to the next generation from their Individual Retirement Accounts (IRAs). For those that have overfunded these accounts, they realize that all or part of it will be left to their heirs and that taxes could eat up a significant chunk. Life insurance may be a tax-advantaged way to fund this “gap” caused by taxes and provide added death benefit protection to their heirs.

Since the assets in these accounts are usually all pre-taxed, the balance in the account will be subject to ordinary income tax at the time it’s passed onto the beneficiaries. Fortunately, preserving and protecting these hard-earned assets to pass on to the next generation can be achieved with some advance planning.

IRA Maximization is a strategy specifically designed to help these individuals reposition this portion of their assets, known as “leave on” money, into a more tax efficient vehicle at death. When done correctly, distributions from an IRA fund a life insurance policy, helping to manage the tax liability and maximize the amount that passes to beneficiaries, free of income and estate taxes. This concept works well for those who need both death benefit protection and wish to maximize their IRA legacy. 

Whether the individuals want to “leave on” part or all of their retirement funds, repositioning retirement assets into a life insurance policy should be a consideration. Unlike a traditional IRA or a 401(k), where every dollar is taxed, with life insurance the cash values can be accessed on a more favorable tax basis. The death benefit is typically income tax free.

Utilizing an Irrevocable Life Insurance Trust (ILIT) can remove the assets from a taxable estate. The owner makes annual distributions from the IRA, which pays the taxes on the withdrawals, and funds the life insurance inside the ILIT. Repositioning assets into a favorable tax saving vehicle means you can leave more to your beneficiaries. However, an ILIT is not necessary if you do not have a taxable estate.

On the other hand, if the heir is receiving money directly from the IRA, the income tax from the income in respect to a decedent (IRD) erodes much of the wealth. The funds received from the life insurance policy are tax free. An option is to begin withdrawing taxable distributions at age 72 or earlier from your traditional IRA, 401(k) etc., to fund a life insurance policy. This strategy is effective for managing forced distributions and could reduce the IRD and potential estate tax burden while simultaneously increasing the amount of wealth transferred to beneficiaries.

Today, the estate and gift tax exemption is $11.58 million per individual or $23.16 million per couple. It is due to “sunset” no later than 2026. The exclusionary amount in 2026, by all indications, will be $5 million for an individual and $10 million for a couple. 

• Need for death benefit protection from life insurance
• Evidence of insurability is needed to qualify
• Must pay taxes on IRA withdrawals
• Design a policy to remain in force at death (if married, utilization of a survivorship policy)
• Creation of an ILIT involves legal work (ILIT applies for life insurance; ILIT is generally utilized if the client has a taxable estate, if not, ILIT is not necessary)
• The portion of your assets that would be repositioned into a life insurance policy must not be needed for retirement income in your retirement plan 

High-net-worth individuals find using life insurance for this IRA Maximization strategy appealing for many reasons. Offsetting taxes for the heirs is a motivator. When you enjoy good health, protection from the tax free death benefit far outweighs the taxes that you must pay on the distributions from the IRA which will be used to pay the premiums.

When you want to leave your IRA to a charity, you can completely eliminate the taxes by leaving the whole IRA to the charity and then purchase a life insurance policy equal to the projected IRA value at death for your heirs. You may want to enhance the legacy and protect your portfolio by adding a long term care rider* to the policy.

While the SECURE Act has eliminated the ability to stretch an IRA for the next generation in most instances, you may still have options for structuring restraints on the money left to “spendthrift” or troubled heirs. With the utilization of trust planning coupled with life insurance, you can create a multigenerational legacy plan.

As a reminder, your spouse has more choices when you are receiving IRA assets, and life insurance can play an important role. For example, life insurance can provide the liquidity to pay the taxes on the inherited IRA, allowing for a Roth IRA conversion. Now, the spouse can take as little or as much as needed annually without having to pay taxes. Also, the growth that is now in the Roth IRA grows tax free. 

Provide death benefit protection while increasing legacy to heirs and charities by:

• Offsetting taxes
• Eliminating taxes
• Enhancing legacy
• Protecting the portfolio
• Providing multigenerational legacies
• Offering a spousal Roth IRA

Many recent changes introduced by the SECURE Act are widely unknown to the general public. The legacies that could be stretched over an heir’s lifetime have been reduced to 10 years in most cases, unless the beneficiary is an “eligible designated beneficiary” (EDB), defined as a surviving spouse, minor child, disabled or chronically ill person, or a person not more than 10 years younger than the deceased qualified plan participant or IRA owner.

For more information about IRA Maximization or the SECURE Act, reach out to your Family Risk Manager who can facilitate an introduction with one of our licensed professionals on the Truist Life Insurance team.