“Where am I going to find the money for life insurance?”
That’s usually the first reaction when life insurance is brought up as a planning solution. It’s actually the second question after “How much is it going to cost?”
Helping clients find the money can help both you and the client get their plan done. I’m a big believer in leveraging assets through life insurance — though I don’t sell life insurance. I’m a tax advisor and life insurance is the single biggest tax benefit in the tax code.
While it is available to most clients, it is still not used as much as it should be. One reason is that many clients believe they don’t have the money to pay the premiums — but they do! Here are three sources of funds that most clients have, that are often untapped.
(1) IRAs (and other retirement plans)
IRAs are loaded with taxes. That money is better used to fund either Roth IRAs as Roth conversions or (even better) life insurance. Both options can transfer taxable funds to tax-free territory — permanently.
However, the leverage is better for life insurance than Roth IRAs. IRA funds grow tax-deferred, which means that money will be subject to tax in the future, probably at a higher future tax rate on a higher IRA balance.
There is no choice here. The tax will eventually have to be paid. In addition, distributions are required after age 70 ½, whether the client needs the funds or not. That takes control out of the hands of the client.
For a client who wishes to have the best of both worlds, tax-free retirement funds and better control over future distributions, life insurance is a better planning strategy, especially if the IRA funds won’t be needed during life and the client wants to pass those funds to beneficiaries.
The possible elimination of the stretch IRA is yet another reason that life insurance is a much more tax-efficient and reliable estate planning move. The better option is to take down IRA funds, pay the tax now, on a lower balance at a likely lower rate and then use (leverage) the remaining funds (after taxes) to fund life insurance. The family will end up with more money and more of it tax free. No need to worry about future higher tax rates.
The same planning holds true for 401(k) and other company plan funds, except those may not be as accessible as IRA funds. IRA funds can be withdrawn at any time; however there would be a penalty for withdrawing IRA funds before age 59 ½.
The optimum time to use this IRA to life insurance strategy is when clients are (1) in their 60’s; when (2) there is no longer a 10 percent early withdrawal penalty and (3) before required minimum distributions begin. Use IRA funds to turn taxable money to tax-free life insurance. The family will end up with more, and that is a good long-term plan.