The SECURE Act of 2019 has reshaped the landscape for beneficiaries of IRAs and other retirement accounts by imposing stricter distribution requirements. Under this act, non-spouse heirs are now required to withdraw the entire balance of an inherited IRA within 10 years, whether it's a traditional or Roth IRA.
This change minimizes the ability to defer taxes over an extended period, presenting new challenges in estate planning. As a result, life insurance has emerged as a compelling solution for those looking to preserve IRA assets for their beneficiaries.
By strategically utilizing life insurance, individuals can draw down IRA funds at comparatively low tax cost and transfer these funds into a life insurance policy. This approach not only enhances the inheritance size but also minimizes tax liabilities, as life insurance proceeds are typically received income tax-free. Certain trusts can also make the proceeds estate tax free!
Life insurance provides several advantages over traditional IRAs. It eliminates the need for required minimum distributions and circumvents the limitations imposed by the SECURE Act. Effectively, life insurance can replicate the benefits of a stretch IRA without the associated tax implications. Moreover, for individuals in second marriages, life insurance offers tax-free liquidity to beneficiaries and avoids probate, addressing potential qualified terminable interest property (QTIP) issues. Additionally, life insurance can function as a tax-free retirement account. Unlike IRAs, there is no cap on tax-free funds that can be accumulated within a life insurance policy. The cash value of life insurance can serve as an alternative to taxable retirement funds, reducing taxes during retirement and providing tax-free income without triggering stealth taxes. Furthermore, and depending on the exact type of contract, life insurance can avoid investment risk and in effect create a separate and distinct asset class.
However, it’s important to acknowledge the limitations of life insurance. Insurability is a requirement, and premiums are not tax-deductible. Despite these considerations, life insurance remains a robust tool for enhancing inheritance and minimizing taxes for beneficiaries. Notably, the tax advantages associated with life insurance are perceived to be more stable compared to potential changes in the taxation of retirement accounts.
This is not to be considered tax or legal advice. Please consult with the appropriate professional resources.
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Our Life Insurance Expert
James is a 40-year veteran of the life insurance marketplace in the Greater Chicago area. His career has included a 22-year association as a branch manager and senior account executive with Hartford Life, earning top national office and top national account executive designations, while qualifying for award-conference level in 20 of those 22 years.
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