Wealth Transfer Planning 3 of 6
Proactive wealth transfer planning is about control and leverage. We believe that a successful estate distribution plan is one in which your heirs (and/or charity) receive as much as possible, and Uncle Same, as little as possible. But this requires some work. Depending on your heirs’ tax brackets and state of residence, almost a third of certain qualified assets value could be lost to federal and state income taxes.
Take this current hypothetical situation:
- Husband and wife, both age 59
- Combined current 401(k) and IRA balances are $750,000
- Plan to contribute $15,000 annually until retirement (age 66) with a hypothetical growth rate of 4%
- Primary beneficiary is each other, secondary their 3 children
- They only withdraw their required minimum distributions throughout their retirement
- Both passed away at age 90, having taken $1,375,000 in gross distributions over their lifetimes
- The remaining before tax balance to their beneficiaries is $950,000
- Beneficiary distributions from the qualified assets are spread out over a number of years so that each can retain the 25% federal tax rate
Take a look at how the assets are being distributed. Under the current plan, the IRS is like having a 4th child, as they will be equal 25% beneficiary of your IRA assets. To address this, one option would be to use portion of your IRA assets (even above the RMD distributions) to purchase a life insurance policy. Because permanent life insurance is distributed income tax free, this strategy would enable you to pass on more to your children.
Here’s how this more heir-centric strategy would work:
- Insurance policy face amount of $1,000,000
- IRA distributions start at $15,000 at age 66, and continue above the RMD amount by $15,000 a year starting at age 71, and grow at 2.5%
- Both passed away at age 90, having taken $1,735,000 in gross distributions over their lifetime, $325,000 of which was used to pay insurance premiums
- Remaining before tax balance to beneficiaries at death (age 90) reduced to $377,000
- Beneficiaries still taxed at the federal tax rate of 25% on remaining qualified assets, but receive $1,000,000 in tax-free death benefit from policy
As you can see, this strategy reduces the income taxes due to the IRS by your heirs after death and increases the after-tax inheritance. Net of premiums, you’ve received nearly the same distributions throughout your retirement. You’ve spread out the taxes owed over your lifetime and leveraged the additional distributions into a tax-free inheritance. However, the IRS is still a significant beneficiary of your assets and you still have yet to address charitable legacies with the scenario.
With this strategy, it is important to note that the premium amount for life insurance will vary based on your health and age at the time you apply for the policy. It is important to discuss your personal situation to determine if this strategy is right for you.
If leaving money to charity is a goal, look at this final option:
- Again, you could leverage a portion of your IRA assets to pay insurance premiums over time
- The insurance policy still provides your heirs with a substantial income tax free legacy
- You could then name your favorite charities as beneficiaries of your qualified accounts
- Since charities don’t pay income tax, you’ve eliminated the IRS as a beneficiary all-together
Obtaining life insurance is not always an easy process, as one must be healthy enough in the eyes of an insurer to make the risk worth their while. But the death benefit could be great leverage for your heirs. And if you’re charitably inclined, there are great tax benefits to the zero tax plan shown here as well. That’s the concept of the 9 circles.
Guarantees are based on the claims paying ability of the issuing insurance company.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. Haas Financial Group, US Financial Advisors and LPL Financial do not provide tax advice or services.
Securities offered through LPL Financial, Member FINRA and SIPC. Investment advice offered through U.S. Financial Advisors, a registered investment advisor. U.S. Financial Advisors and Haas Financial Group are separate entities from LPL Financial.
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