$16.6 Trillion. According to the Investment Company Institute in Washington, that’s how much money Americans have stashed in qualified retirement plans as of the end of 2006. It’s a lot of money, and it’s never been taxed.

Many, if not most, Americans believe their qualified retirement plan is a great tax shelter. And why shouldn’t they? They hear from every financial source that they should put as much money as possible in their qualified retirement plans. Everyone seems to agree that these types of tax shelters are “good” and should be utilized and that the only argument is where to invest the money once it’s inside the plan.

But what happens at retirement? What happens when it’s time to withdraw money from these accounts? That’s when we discover that our qualified retirement plans are our highest taxed asset. No other asset, throughout our entire lives, is taxed at a higher level than our qualified retirement plan in retirement.

All signs point to tax rates increasing at some point in the near future whether we want them to or not.

So let’s add this up: trillions of dollars in retirement plans that have never been taxed plus higher future tax rates. It all equals a very ugly tax picture for retirees.

So what is a retiree to do? To answer that question, let’s take a look at a typical retiree with $500,000 in his retirement accounts. We’ll make the following assumptions:

–Both husband and wife are 65 years old and in good health.

–The IRA is in the husband’s name (Joe) and the wife (Carol) is the primary beneficiary.

–Using TIAA-CREF’s 2003 mortality tables as a guide we’ll assume that at least one of them will live to age 90.

–They are conservative investors, so we’ll use a 6% rate of return.

–We’ll use a 25% tax rate.

Let’s take a look at this spreadsheet together (Figure 1) to see if this plan, which many people follow, makes any sense at all.

(Q) How much money does Joe withdraw in the early years, while tax rates are still at historic lows? $0 now and only $25,000-$30,000 in the first few years of distributions.

(Q) How much money does Joe withdraw in the later years, after tax rates have increased? $75,000-$90,000. (Don’t forget the $1 million+ taxable balance to the heirs.)

(Q) Does it make any sense at all to withdraw small amounts when tax rates are low and large amounts when tax rates are high? Obviously not.

(Q) What should Joe do? Start taking out money right now while tax rates are lower!

Now that Joe is retired, he needs to deal with this tax monster called a qualified plan. His goal should be to reposition his now “tax-hostile” qualified funds to a more “tax-friendly” environment (ideally tax-free). This can happen all at once or over time.

If Joe wants to move to “tax-free” (and who doesn’t?), then he has two potential destinations for his retirement dollars that he should consider: a Roth IRA or Maximum Funded Life Insurance.

Both potential destinations for his retirement dollars offer the following advantages, assuming that the life insurance is properly designed:

–Tax-Free or Tax-Deferred growth.

–Tax-Free distributions (using withdrawal to basis or loans with the insurance).

–Tax-Free death benefit to heirs.

–No impact on level of Social Security Income taxation when funds are withdrawn.

–No required distributions allowing for complete freedom of either using the money or reinvesting.

The life insurance may offer an additional advantage. Many of today’s insurance plans include a long term care rider that may either be free or have a nominal charge.

Let’s look at the situation where Joe elects to transition his account to either the Roth IRA or a Maximum Funded Life Insurance plan over a 10-year period. If you run the numbers, you will find that Joe needs to move roughly $67,900 each year. At a 25% tax rate, he pays $16,975 of tax leaving $50,925 to reposition.

He can either convert the after-tax amount of $50,925 into a Roth IRA or pay the $50,925 into a 10-pay life insurance plan. His minimum death benefit would approximate $698,000. This process is then repeated each year over the next 10 years (assuming that tax rates do not increase during that time period). If rates increase, appropriate adjustments can be made.

When you calculate this approach, you learn that in many cases, the Maximum Funded Life Insurance provides the best result, often by hundreds of thousands of dollars. If you add in the fact that certain life insurance carriers are including free LTC riders on their policies, you end up with a terrific solution for your client.

Additionally, should your client desire that their beneficiaries receive their account in the form of a “Stretch IRA,” you can have the life insurance death benefit paid into a trust that provides the same benefit, with a significantly better tax result assuming that the funds within the trust are invested in a tax-efficient manner.

Finally, take a look at the total amount of taxable distributions from Joe’s qualified retirement plan should he choose to make a transition to a more tax-friendly environment. He distributes $67,900 for 10 years until the qualified retirement plan is exhausted. That totals $679,000 that he pays tax on. Compare that to Figure 1 and you will see that he and his wife, Carol, pay tax on roughly $1.1 million leaving an additional $1 million taxable for the heirs.

By moving to a tax-friendly position, Joe is able to pay tax on $679,000 vs. $2.1 million. This represents a significant tax savings for him and his family!

Michael D. Reese, CFP(R), CLU, ChFC is the managing director of Centennial Wealth Advisory, LLC in Traverse City, Mich. He can be reached by e-mail at .