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New Developments Transform the Role Life Insurance Plays in Your Estate and Financial Planning

On Behalf of | Feb 8, 2021 | Firm News

A combination of new legislation and the recent change of leadership in Washington stands to dramatically increase the income taxes on your taxable investments and the income taxes your loved ones will have to pay on inherited retirement accounts. However, purchasing life insurance may offer you the opportunity to minimize the effect of these developments.

Therefore, if you hold assets in a retirement account, you need to review your financial plan and estate plan as soon as possible. You should determine if investing in life insurance or some other strategy may offer you and your family tax-saving benefits. Here we’ll discuss how these new developments might affect your taxes owed by you and your heirs. And we’ll discuss how investing in life insurance may help offset the recent changes’ tax impact.


Proposed legislation stands to harm the tax consequences for your retirement and estate planning

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, your retirement account beneficiaries 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65 years could inherit an IRA and stretch out the distributions for 65 years, paying income tax on just the portion withdrawn each year.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, must 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 on inherited investments.

Democrats Take Control

Democrats take control

As we highlighted in a previous article, the recent election of Joe Biden and subsequent Democrat 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, Democrats will likely pass legislation aimed at eliminating many of the tax cuts enacted through the 2017 Tax Cuts and Jobs Act within the next two years. 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

Consider investing in life insurance

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 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 minimize the income taxes you pay over your lifetime. And it could significantly reduce the tax bill imposed on your designated beneficiaries after your death because 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 income tax basis step-up upon your death, which we’re likely to see enacted through Democrat-backed legislation. 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, suppose you stand to be affected by the proposed decrease of the federal estate tax exemption, 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 proposed legislation stands to harm 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 Democrats’ proposed legislation, you and your family could face a significantly higher tax bill. To prevent this from happening, schedule a Planning Session or an existing estate-plan review today.

We will 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 proposed legislation 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 Ruberg Law PLLC. We don’t just draft documents; we ensure you make informed, empowered decisions about life and death, for yourself and the people you love. That’s why we offer a Planning Session during which you will get financially organized and decide what YOU want for YOUR family. You can begin by calling our office today to schedule your Planning Session at no charge.