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3 places clients can find money for life insurance

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“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 IRA funds can be withdrawn at any time; however there would be a penalty for withdrawing IRA funds before age 59 ½.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.  

(2) Taxable investments and savings accounts 

Look at a client’s list of assets. Look for taxable (non-IRA) investments. These can include bank and savings accounts, funds and stocks etc. Banks accounts that are earning virtually zero interest are the best funds to use first (unless needed by the client for emergencies or cash on hand for security). These funds do nothing and earn nothing; plus, unlike IRA funds, they can be withdrawn without a tax bill. They should be leveraged for life insurance, assuming of course there is a planning need for the life insurance. However, the tax free leverage is a good plan in itself, regardless of the need for life insurance. The value of these assets can be dramatically increased through life insurance.  

Mutual funds may fall into the same category as savings accounts except there may be a need to keep some specific funds classes for asset diversification.  

As far as stocks go, be careful. Before you liquidate any stocks to free up cash for life insurance, you MUST know the basis of those stocks. If they are highly appreciated (low tax basis), they should probably be held until death so heirs can get the step-up in basis. That will relieve the family of the income tax on all of the appreciation during life.

Instead, look to sell the losers. That will accomplish two favorable results: It will create a tax loss that can offset other capital gains and free up funds for life insurance. Selling high basis assets or chronic non-performers are another great source of funds for life insurance. It’s time to let go of these assets and make better use of the proceeds.

(3) Dead assets 

By “dead assets” I mean the deadwood that most clients own. Most clients need a good pruning of these assets. Dead assets may include stock that great grandma passed down to them decades ago with the warning to never sell or else!

If they are not highly appreciated and they’re only being held for emotional reasons, they are prime candidates for liquidation. This can include hard assets too, like real estate and other personal property that is only being held because they have had it for so long.

The next generation will likely not have the emotional ties to these assets and will probably end up selling them later anyway. Better to do it now and leverage that money so heirs can receive more.   

When I go through a client’s list of assets I find these types of properties and investments in almost every case. I encourage them to clean house, get rid of the deadwood, free up the cash and leverage it to better use — like life insurance! Turn the deadwood into a fruitful and productive fountain of tax-free money for the family. 

The bottom line is that most clients are bogged down with non-performing and tax-inefficient assets that are also subject to market risk. These should be the first places to look to find money for life insurance, which in turn can provide a guaranteed return and tax-free leverage, leaving clients and their families with more money and a lower tax bill. 

See also these articles by Ed Slott: