Historically, people who had large IRA’s, and who didn’t want their beneficiaries to squander their inheritance all in one year, could use a trust to make sure the funds were released over the course of their lifetime. However, due to the recently passed Secure Act, that beneficiary will be forced to spend down that money over ten years or less.
The good news is that there is a way to control the flow of money in a similar fashion despite the legislation.
Since it makes sense to pay taxes now while taxes are still currently historically low, Roth conversions are one way you can do that, but Roth IRA’s won’t solve the inheritance problem. This is where life insurance comes in.
We know that life insurance can be owned by a trust, and this trust can be required by law to distribute those dollars per the language of the trust. The bottom line is life insurance gives us some flexibility in terms of passing money on to the next generation and being able to control how that money gets distributed.
Instead of preemptively doing Roth conversions with a large IRA, you would instead pay taxes preemptively at historically low tax rates, and then contribute that money to a life insurance policy that is owned by a trust. Your beneficiaries will not get that money in any other way than the way the trust prescribes it.
Life insurance trusts are much more flexible and simple, and you don’t have to navigate a bunch of difficult tax laws.
As great as this strategy is, it doesn’t solve the problem of keeping the money growing tax free over the life of the beneficiary in the way it would with the previous form of the stretch IRA. The IRS is getting wise and is now requiring beneficiaries of Roth IRAs to spend that money down over the course of ten years.
If a beneficiary inherits a huge IRA or Roth IRA, they will need a tax-free receptacle within which they can continue to grow that money tax-free over their lifetime. One of the things that we know about life insurance is that there is no limit on how much money that you can put into the policy.
Ideally, the beneficiary is forced to receive these distributions from a IRA or Roth IRA, or from a trust that owns a life insurance policy, and once received that money is placed into another life insurance policy since life insurance is an excellent vehicle for assets to continue to grow in a tax-free way.
We know that you can touch that money in the life insurance policy before age 59 and a half without a penalty. When you take the money out the correct way, it can be tax-free and there are no contribution limits. We also know that life insurance has been historically granted a grandfather clause. Life insurance seems to be immune to tax rate risk.
If congress decides that someday in the future they want to change the rules around life insurance, existing policies will be exempt and continue operating under the old rules.
Life insurance is the single greatest tax benefit within the IRS tax code. It gives you more flexibility, it allows you to pass money on to the next generation with more simplicity, and allows you to rule from beyond the grave.
The fact that beneficiaries can use life insurance to continue to grow and compound their inheritance in a tax-free way is often lost in the conversation. We need to start thinking about using life insurance as a more efficient way to bypass the constraints of the Secure Act while also using life insurance as a way to grow and compound that wealth for the next generation.
There may be two life insurance policies that need to be purchased, one owned by a trust that allows you to distribute that money at your discretion, and a second policy owned by the beneficiary for use as a receptacle for that money.
The common denominator here is that we probably need to be using life insurance more in retirement planning, more in estate planning, and more in the lives of the beneficiaries of those estate plans. Life insurance is so flexible and offers so many benefits, that’s why it’s such a great tool in the Power of Zero strategy.
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