Life Insurance's New Role in Estate 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 retirement accounts as well as increasing the income taxes you owe on your taxable investments. However, purchasing life insurance may offer you the opportunity to minimize the effect of these developments.


To this end, if you hold assets in a retirement account, you need to review your financial plan and estate plan as soon as possible 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, and 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, and 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 own life expectancy to minimize the income taxes owed on those 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65 years could inherit an IRA and stretch out the distributions for 65 years, paying income tax on just the portion withdrawn each year. In that case, 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 — and pay income taxes on those withdrawals — within 10 years of the account owner’s death. Those who fail to withdraw funds within the 10-year window face a 50% tax penalty on the assets remaining in the account.


But this is just the first development that stands to affect 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 that could have a significant impact on your family’s financial and estate planning considerations.


Specifically, it’s likely that within the next two years Democrats will pass legislation aimed at eliminating many of the tax cuts enacted through the 2017 Tax Cuts and Jobs Act. As part of this 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 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 strategy 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, pay the tax, and invest the remainder in cash-value life insurance. From there, you can access the accumulated cash-surrender value of the life insurance policy income-tax-free during your lifetime via tax-free withdrawals and/or loans. And upon your death, the death benefit of your life insurance policy would be income-tax-free for your heirs.


By annually investing what you would otherwise put into tax-deferred retirement accounts into a cash-value life insurance contract, or by taking taxable withdrawals from your tax-deferred retirement accounts over time and reinvesting them in cash-value life insurance, you can effectively move these funds into a tax-free, rather than tax-deferred, 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 since life insurance proceeds are income-tax-free.


Additionally, by investing a portion of your investable assets in cash-value life insurance, you can offset the effects of the proposed loss of 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, as growth on investments inside a life insurance policy is not subject to income tax, including any capital gains.


Finally, if you stand to be affected by the proposed decrease of the federal estate tax exemption, which is currently set at $11.7 million, 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, either via a so-called “spousal access trust,” if you are married, or via a traditional irrevocable life insurance trust, if you are not married.

Rethink Your Planning


Although the SECURE Act and the proposed new legislation stands to have an adverse effect on the tax consequences for your retirement and estate planning, investing in life insurance may offer you a valuable tax-saving opportunity. That said, 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/or 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, review your plan today.


Now is the time to analyze all of the ways your retirement accounts might be impacted by the SECURE Act and the new proposed legislation to determine 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.



This article is a service of the Law Office of Keoni Souza, LLC, an estate planning law firm in Honolulu, Hawaii. We don’t just draft documents; we ensure you make informed and empowered decisions about life and death, for yourself and the people you love. That is why we offer a strategic planning session, during which you will get more financially organized than you have ever been before and make all the best choices for the people you love. You can begin by contacting our office today to schedule a planning session and mention this article to find out how to get this $750 session at no charge.


Disclaimer: All information on this website is for informational purposes only and is not legal advice. You should contact an attorney trained to work with families on estate planning matters regarding your specific situation. Use of and access to this website or any of the email links contained within the site do not create an attorney-client relationship between the Law Office of Keoni Souza, LLC, and any users or any other party.


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All information available on this website is for informational purposes only and is not legal advice. You should contact an attorney directly regarding your specific situation. The use of and access to this website or the transmission of information via email or through this website does not create an attorney-client relationship between the Law Office of Keoni Souza, LLC and any users or any other party. Transmission of information via email or through this website may not be secure, therefore confidentiality cannot be assumed.  By using this website or transmitting information via email or this website, the user agrees to this information being collected, stored, or transmitted to a third-party.

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