By David Kopyc
The Baby Boomer generation will pass on an estimated 80-plus trillion dollars of wealth to their family, and this will be the largest wealth transfer in the history of mankind. There are certain types of financial assets that are very complicated to be passed on to the next generation and this article will focus on one in particular – qualified assets (IRA, 401(k).
Qualified assets are estimated to be around $20 trillion of wealth. As I write this article, a vast sum of the money will be 100 percent taxable as ordinary income and never receive a step up in basis at death. These monies have a huge tax obligation sent down to your heirs to pay the tax bill that you left behind.
Previously, financial advisors had the ability to do a stretch IRA, to spread these payments out for decades, but the government discontinued the stretch IRA and now non-spouse beneficiaries have 10 years to have 100 percent of the inherited IRA paid out. That leads me to ask you a question…Do you want to leave a tax liability or do you wish to leave a tax-free benefit for your legacy?
Deciding on that answer can lead you to consider purchasing a life insurance policy to pass some of your qualified assets tax-free to your loved ones. This option does not have to be all or none. At the Retirement Planning Group, we usually do a carve out, with a portion of the qualified assets to be spent down to purchase a life insurance policy. Some of these policies can be paid for over a 10-year, 20-year, or lifetime payout. Depending on your other assets and the size of your estate, you might even have the ability to do a one-time payment.
Life insurance isn’t something only the wealthy use for wealth transfer and estate preservation. There are several unique features of life insurance, but the two that are most beneficial are tax-free and guaranteed values. Many of our clients have used life insurance for a guaranteed wealth transfer, especially if you are in a blended family and you have a substantial age difference between spouses.
When the first spouse passes away (typically the male), a tax-free benefit can be paid to his children to satisfy his legacy desires. The surviving spouse doesn’t have to sell assets off or be involved in an awkward financial situation. This is only one of many solutions for life insurance.
Roth IRAs and life insurance both have a common structure. They are both tax-free wealth transfer options from one generation to another. The biggest difference is, the Roth IRA is always included in your estate. Life Insurance, if it is owned and set up properly inside a Trust, can be excluded from your estate. The problem we see is most individuals are top heavy with pre-tax dollars rather than after tax Roth IRA or Roth 401(k) dollars. Most of this is due to the structure of the 401(k) plan you participated in at your employer, and a lot of high-net-worth people did not qualify for Roth IRA contributions.
Life insurance can be set up so it’s outside your estate and the proceeds at death can be retained by the Trust to act in a fiduciary capacity to have the assets follow your bloodline and meet certain objectives you would like for your family (weddings, college education, future pension benefits for a child that doesn’t have one, etc.). Just like the Roth IRA, there is not a Required Minimum Distribution (RMD) for life insurance. Non-spouse Roth IRA beneficiaries must take the RMD.
If you are looking to leave a tax-free, uncomplicated legacy to your family and loved ones, life insurance should be considered as an option. There is no one size fits all, and every family and situation is different. Seek out competent financial and legal advice and give some thought on how you wish to leave your legacy.