Updated October 6, 2023, at 11:22 AM
Do you have clients who are under the age of 70 ½ who own an IRA, but have no desire to take withdrawals from their qualified accounts until the IRS forces them to begin their required minimum distributions (RMDs) at age 70 ½?
Do you have clients who are 70 ½ and retired who only take distributions from their IRA because they must? Do they anticipate leaving what’s left in their qualified accounts like their IRAs to their kids when they pass?
If you answered yes to those questions, then you should help your clients consider a multi-generational strategy for your clients’ IRA assets.
How the Multi-Generational Strategy Works
The multi-generational strategy is for individuals who want to create a financial legacy that lasts generations. It’s possible when an IRA is passed on directly to grandchildren, since the IRS’s tax deferral period significantly increases.
The basic idea is to purchase life insurance with the RMDs on the IRA to be left to your client’s children. This allows them to take care of their kids while leaving the remainder of the IRA at death directly to the grandkids.
Here’s how it Works:
- Determine the projected value of the IRA when you believe your client would likely pass away. You’ll have to make a few assumptions here; basically, you estimate a “reasonable” rate of return and apply the basic RMD to the account.
- Estimate when you believe the client is likely to pass away. There’s a function in RetireUp Pro that can help with this in our Agent Portal.
- Purchase a life insurance policy using the client’s RMDs to pay the premiums and name their children the beneficiaries of the life insurance. The life insurance policy can be structured in many ways. For example, if you’re working with a married couple, you can minimize the premium required by writing a second-to-die policy, or if future LTC costs are a concern, you could look at a policy with LTC benefits.
- Finally, name their grandchildren as the beneficiary of their IRA. If you’re working with a married couple, you may want to name the spouse as the primary beneficiary of the IRA and name the grandchildren as contingent beneficiaries. That way, when the original IRA owner dies the IRA is left to their spouse; the spouse could assume the IRA via the IRS spousal assumption rules and then name the grandchildren as their primary beneficiary.
Strategy Example
John, age 70, has an IRA worth $500,000 that he wants to leave as an inheritance to his son James, age 45, and his grandson Greg, age 13. We’ll assume that John lives to age 80 and work with the 6% average rate of return. That would mean if John only withdrew his RMDs from his IRA, it’d be worth $577,208 at his death and that balance would be taxable to his son.
Instead of leaving the IRA to his son James, John purchases a life insurance policy with a death benefit of $577,208 with an annual premium of $19,936 from Protective Life. When John dies at age 80, his son James receives the death benefit from his life insurance policy of $577,208 (tax-free).
John named his grandson, Greg, as the beneficiary of his IRA and James receives the IRA upon his grandfather’s death. Greg is 23 at the time of his grandfather’s death and chooses to treat the account as an inherited IRA. James begins taking RMDs the year following his grandfather’s death and continues taking only RMDs based on his age until his death at the age of 90.
The forecasted IRA distributions over his lifetime (assuming a 6% annual rate of return) would be $6,747,694. The total distributions then total $7,324,902 ($577,208 tax-free life insurance proceeds to James plus $6,747,694 in RMDs paid to Greg over his lifetime.)
What may have happened had John not implemented this strategy? John could have earned the same 6% as we assumed in our example on his IRA and only taken RMDs from his account until his death at the same assumed age of 80.
His son, James, receives the $577,208 IRA balance, which is fully taxable. And, instead of treating it as an inherited IRA, he liquidates the account. If we assume a 35% tax bracket, then after taxes that leaves him with $375,185. James could also treat his inheritance as an inherited IRA and take RMDs based on his life. If he chooses that option and takes RMDs during his lifetime, and we assume the same 6% rate of return, then the sum of his RMDs would total $1,619,733.
Tax-Efficient Wealth Transfer
IRA maximization is a wealth transfer strategy that can allow your clients to transfer the value of their IRA to their heirs in a tax-efficient manner, while also leveraging the value of life insurance death benefit proceeds.
Who might benefit from this strategy? Someone who doesn’t need their IRA assets to provide them income during their retirement and who’s interested in maximizing the legacy they leave to their loved ones.
The information in this article is for educational purposes only and does not constitute legal or tax advice. Customers should consult their legal or tax advisors regarding their own situation. Rates of return discussed in this article are illustrative in nature and may not represent an actual rate of return one may receive.