Life-insurance-based retirement strategies will look even more appealing if President Barack Obama's pitch to cap IRAs at $3.4 million becomes a reality.
Clients with large individual retirement account balances could consider making a withdrawal, paying any applicable taxes and using those proceeds to buy a life insurance policy.
Retirement plan assets are “bad assets” in terms of estate-planning vehicles. Beneficiaries could end up stuck with income taxes.
Meanwhile, life insurance pays out to beneficiaries free of income tax, and if it is structured in an irrevocable trust, it could pass through free of estate taxes.
“You are converting a bad asset to a good one,” said Jeremiah W. Doyle IV, an estate-planning strategist for BNY Mellon Wealth Management.
Cash value life insurance could also be a reasonable savings alternative because it grows tax-deferred, said Matt Klein, managing partner at Matauro LLC, which specializes in life insurance planning.
Universal life insurance, variable or indexed, could be positioned so that premium dollars are going largely toward cash accumulation.
In this context, the death benefit isn't the sole purpose of the policy, Mr. Klein said. Rather, it is the tax-deferred-growth capability of the policy and the fact that clients can take tax-free withdrawals from the cash value to help fund costs in retirement.
RISKS REMAIN
Still, there is some risk in using these policies. For instance, during the market downturn in 2008, variable-insurance policies took a beating because their underlying investments tanked.
Those policyholders expecting strong market performance were blindsided when they ended up with policies with dwindling cash values that had to be propped up with even more premiums.
Any strategy that positions life insurance as a retirement savings and income vehicle needs to be monitored on a regular basis, Mr. Klein warned.
Further, this is more of a tax diversification play for retirement income and should be considered only part of the client's overall strategy.
“The trick is to make sure everything is healthy on an annual basis,” Mr. Klein said. “It's like if you bought a Gremlin: It's the coolest thing in the world — if you take care of it.”
There also are some strategies plan sponsors can use to help boost supplemental savings.
Nonqualified plans could be a way to increase savings for highly compensated workers, said Edward M. Lynch Jr., managing director at Dietz & Lynch Capital.
Such concepts include supplemental compensation plans, which allow the employer to finance the worker's supplemental savings, and the death-benefit-only plan, in which the employer pays a benefit to the worker's beneficiary if the employee dies.
These plans are already used in situations where employees earn so much money that they could save beyond the $17,500 annual limit in their 401(k) and the $5,500 limit for IRAs.
