Speakers Put Sizzle In Estate Planning

Life insurance can fulfill multiple functions as well in retirement planning. Jim Johnson, a Chartered Financial Consultant and vice president of advanced sales development at Allianz Life Financial Services, Minneapolis, Minn., cited using life insurance to help qualified plan participants and IRA owners make the most of their ability to stretch retirement account distributions.

Under a basic stretch plan, a 401(k) participant or IRA owner delays distributions for as long as permitted by a uniform or life expectancy table. The individual names a young beneficiary, such as a child or grandchild, that will minimize distributions and, at the mandated age of 70 1/2 , distributes the minimum amount required.

Earnings on the account can continue to growth tax-deferred, creating potentially substantial wealth for future generations. And, assuming the account owner has other retirement assets to live on, the unused RMDs can fund premiums of a life insurance policy that later may be used to pay estate taxes–thereby maximizing the stretch.

To illustrate, Johnson cited a hypothetical couple, Jack and Jill, ages 70 and 64, respectively. Jack, the owner of an IRA valued at $500,000, names his wife as the beneficiary. After beginning required minimum distributions in December of 2010, Jack dies at age 72 with an account valued at $537,252 (5% growth, less the RMDs).

Jill, now age 66, treats the IRA as her own and begins taking distributions when she reaches 70 1/2 . As IRA owner, she names her grandson, John (age 13), as the account beneficiary. Jill subsequently lives to age 75, receiving distributions for 6 years. John, now age 22, takes distributions totaling nearly $5 million over his lifetime of 61.1 years, netting around $3.25 million after paying a 35% income tax on the distributions.

To maximize distributions to John, estate taxes due at Jill's death are covered by a survivorship life insurance policy on the lives of Jack and Jill, Jack's unneeded RMDs being used to fund the premiums, Johnson added.

Death benefit proceeds can also be used to help replace assets lost to income tax on income in respect to a decedent. These IRD assets are subject to income tax even if the estate is not subject to estate tax, said Johnson.

"The thing that surprises most people is what constitutes IRD assets," he said. "The answer is virtually everything–annuities, traditional IRAs, 401(k)s, SEPs and 412(i) plans. Taken together, these assets can result in a significant income tax for clients. Also, many advisors fail to understand that Internal Revenue Code Section 691(c) permits a deduction for estate taxes paid on qualified plan money. But if there is no taxable estate, then Section 691(c) doesn't come into play."

Life insurance can be used to pay income tax on a conversion from a traditional IRA to a Roth IRA, distributions from which pass to beneficiaries income tax-free if all requirements are met. The unneeded RMDs are used, as in the earlier example, to pay the policy premiums. Depending on the estate value, insurance covering a surviving spouse's life insurance can also pay off estate taxes, he explained.

The value of a policy will be all the greater come 2011, because income tax rates are due to rise then, said Johnson. The current rates, now 25%, 28%, 33% and 35%, will automatically change after 2010 to 28%, 31%, 36% and 39.6%, respectively, without Congressional action.

"So you need to be careful as to when you do a Roth conversion and pay income taxes," said Johnson. "Tax rates aside, advisors should make life insurance part of the conversation process to help clients pass on as much of their qualified plan assets as possible."