There are more workers entering their retirement years now than at any other time in American history. It’s no surprise that television, magazine, and newspaper ads are all focused on retirement planning. Wealth transfer has been put on the back burner, a topic reserved for the older, affluent client. It’s time to make wealth transfer an integrated part of retirement planning.
How the needs stack up
The retirement needs hierarchy model (see chart) demonstrates wealth transfer as a planned allocation of income.
Retirement needs and wants are ranked in a defined order on this pyramid. Until your clients can meet their basic needs, plan for their healthcare and fund their dreams, they likely won’t be willing or able to exercise their desire to transfer wealth to heirs. But as you develop an effective framework for your clients to manage their retirement income, the transfer of their wealth should be an integral part of the plan.
The capital transfer strategy is an effective wealth transfer planning strategy that can: (1) minimize the effects of taxation; and (2) maximize the value of assets earmarked for the next generation.
What is the capital transfer strategy? The name says it all. It is simply the act of transferring capital from one asset to another. The strategy lets an individual replace a “negative tax consequence” asset with an asset that provides a favorable after-tax result.
Qualified retirement plans–traditional IRAs, 401(k)s, etc.–are remarkably efficient accumulation vehicles. Untaxed dollars are used to fund the plan, and taxes are deferred as long as the funds remain in the plan.
But qualified retirement plans become inefficient vehicles when funds are distributed at retirement. And at death, qualified plan accumulations may be subject to double taxation: both income and transfer taxes. If a person dies with money in a qualified plan, income tax may be levied when funds are distributed to heirs. And when your estate is large enough, transfer taxes, including federal estate and state inheritance taxes, also come into play.
After they reach age 70 1/2 , clients must take annual required minimum distributions whether income is actually needed or not. Failure to take the required distribution results in a whopping 50% penalty tax levied on the amount not withdrawn.
The capital transfer strategy lets an individual place retirement dollars in the most tax-efficient vehicle for transferring property to heirs. That tax-efficient vehicle is life insurance. Properly designed and funded, life insurance passes income tax-free to heirs, preserving the legacy your client intended for them to enjoy.
If the life insurance is owned by the beneficiaries or an irrevocable life insurance trust (ILIT), the life insurance proceeds will pass to the heirs without being subjected to estate or other transfer taxes. Life insurance is the most efficient vehicle for transferring dollars from one generation to the next.
But how do you integrate the capital transfer strategy into your client’s retirement plan other than seeing it as an allocation of expenses?
Retirement is not a static event; rather, it is a progression of stages, or a continuum. Your clients have changing interests and needs at each step. There are basically 4 stages in the planning process. The capital transfer strategy can be integrated in any one of the 4 stages.
Stage 1: Pre-retirement (the 10- to 15-year period leading up to retirement). During this time, clients need to assess their retirement savings and income needs, make decisions about their retirement plan, and consider which options they should select for the distribution of retirement funds from their employer-sponsored plans. Moving part of their qualified dollars into life insurance at this stage provides:
? Risk protection against premature death.
? A pension maximization tool.
? Supplemental retirement income in the later stages through withdrawals and loans if the policy is not a modified endowment contract.
? Supplemental long term care coverage if the policy has an accelerated death benefit rider.
? Life insurance that can be moved to an ILIT to remove the policy from estate taxation for wealth transfer purposes.
Stage 2: Initial retirement (the first 5 to 10 years of retirement). This is often an exhilarating period when people reconnect with family, travel, start a new business venture, or devote time to hobbies, avocations or new lines of work. However, this period also marks a time of emotional and financial transition. The capital transfer strategy may be very appealing in this stage as life insurance:
? Minimizes the effects of taxation.
? Maximizes the value of assets for the next generation.
Stage 3: Seasoned retirement (lasts from 10 to 30 years). Retirees will slow down during this period, although it is also a period of increasing contentment. This is the time when most individuals begin transferring life insurance into ILITs or to children to keep the death proceeds out of their estate.
Stage 4: Mature retirement. Not everyone will reach this phase, which may happen at any age and include periods of long-term illness or nursing home care. Planning for this period is critical. If life insurance with accelerated death benefits was purchased in earlier stages, it can provide additional funds during this period. It is also during this stage that many retirees finalize their plans to transfer wealth to heirs to ensure their legacy continues.
As you work with your clients to estimate expenses and income for each stage of retirement, you must manage their assets to provide that estimated flow of income. Things you will want to consider include how to:
? Allocate certain assets for income.
? Invest conservatively for the next stage.
? Invest some assets to assure future income.
? Reallocate at the beginning of each stage.
Once your clients have an effective retirement income management model, the capital transfer strategy can let them relax and enjoy life.