New Developments Transform the Role Life Insurance Plays in Your Estate and Financial Planning
Within the past year, a combination of new legislation and the recent change of leadership in the White House and Congress stands to dramatically increase the income taxes your loved ones will have to pay on inherited accounts as well as increasing the taxes you owe on your taxable investments. However, purchasing life insurance may offer you the opportunity to minimize the effect of these developments on your loved ones.
To this end, if you hold assets in a retirement account, you need to review your financial plan and Will and Trust to determine if investing in life insurance or some other strategy may offer tax-saving benefits for you and your family. To help you with this process, here we’ll discuss how these new developments might affect the taxes owed by you and your heirs. In addition, we’ll also discuss how investing in life insurance may help offset the tax impact of these new changes.
The SECURE Act
At the start of 2020, the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) went into effect. The new law effectively put an end to the so-called “stretch IRA.” Under prior law, beneficiaries of your retirement account could choose to stretch out distributions of an inherited retirement account over their life expectancy to minimize the income taxes owed on the distributions.
For example, an 18-year-old beneficiary expected to live an additional 65 years could inherit an IRA and stretch out the distributions for 65 years. This would allow the beneficiary to pay income tax on just the portion that is withdrawn each year. Due to this, the income tax law would encourage the child not to withdraw and spend the inherited assets all at once.
Under the new law, however, most designated beneficiaries of inherited IRAs and similar tax-deferred qualified retirement accounts are now required to withdraw all of the assets from the inherited account within 10 years of the account owner’s death. Those who fail to withdraw funds within the 10-year face a 50% tax penalty on the assets remaining in the account.
But this is just the first development that affects the amount of taxes your heirs might face in the near future on inherited investments.
Democrats Take Control
As we highlighted in a previous article the recent election of Joe Biden as President and subsequent Democratic takeover of the Senate will likely result in the passage of new tax legislation. This new legislation could have a significant impact on your family’s financial and Wills and Trusts planning considerations.
Specifically, it’s likely that within the next two years they will pass legislation aimed at eliminating many of the tax cuts enacted through the 2017 Tax Cuts and Jobs Act. As part of this potential legislation, we’re expected to see significantly lower federal estate tax exemptions, the elimination of the step-up in cost basis on inherited assets, as well as an increase in the top personal income and capital-gains tax rates.
One way you may be able to minimize the new taxes laws on both your tax-deferred retirement accounts and taxable investments is by investing in cash-value life insurance. Let’s break down exactly what this might look like.
The New Role of Life Insurance In Your Estate and Financial Planning
Given the new distribution requirements for inherited IRAs, you should consider whether it makes sense to withdraw funds from your retirement account now and invest the remainder after paying taxes in cash-value life insurance. From there, you can access the accumulated cash-surrender value of the life insurance policy tax-free during your lifetime via tax-free withdrawals or loans. And upon your death, the death benefit of your life insurance policy would be tax-free for your heirs.
By annually investing what you would otherwise put into tax-deferred retirement accounts into a cash-value life insurance policy, or by taking taxable withdrawals from your tax-deferred retirement accounts and reinvesting them in cash-value life insurance, you can effectively move these funds into a tax-free investment vehicle.
This strategy could not only minimize the income taxes you pay over your lifetime, but it could also significantly reduce the tax bill imposed on your designated beneficiaries after your death.
Additionally, by investing a portion of your investable assets in cash-value life insurance, you can offset the effects of the proposed loss of income tax basis step-up upon your death. What’s more, this strategy would also minimize your current income taxes on what otherwise would have been taxable income from your investments.
Finally, if you stand to be affected by the proposed decrease of the federal estate-tax exemption, by placing the life insurance policy inside an irrevocable life insurance trust, you can remove the death benefit paid out to your beneficiaries from your taxable estate. In doing so, you would still be able to access the cash value of the insurance policy during your lifetime.
Rethink Your Planning
Although the SECURE Act and the proposed new legislation stand to have an adverse effect on the tax consequences for your retirement and Wills and Trusts planning matters, investing in life insurance may offer you a valuable tax-saving opportunity. However, you can only take advantage of this opportunity if you plan for it.
If you fail to revise your plan to address the SECURE Act’s new requirements and the proposed legislation that’s likely to be passed, you and your family could face a significantly higher tax bill. To prevent this from happening, schedule a Family Wealth Planning Session™ or an existing estate-plan review with us today.
With us as your Personal Family Lawyer®, we’ll work with you and your financial advisor to analyze all of the ways your retirement accounts might be impacted by the SECURE Act and the new proposed legislation. We will then work with you to come up with the most effective planning strategies for passing your assets to your loved ones in the most tax-advantaged manner possible, while ensuring your current tax liabilities are similarly minimized. To learn more, contact us right away.
This article is a service of Levi L. Alexander, Personal Family Lawyer®. We do not just draft documents. We help to ensure you make informed and empowered decisions about life and death, for yourself and the people you love. This is why we offer a Family Wealth Planning Session™. During this session, you will get more financially organized than you’ve ever been before and make all the best choices for the people you love. You can begin by calling our office to schedule a Family Wealth Planning Session and mention this article to find out how to get this $750 session for free.
