ALLiS Login | phone icon (877) 254-4429

Policy Matters



You may have heard this from one (or more) of your clients: “I don’t want the money. Why do I have to take it?” As your clients near age 70½, they’ll receive required minimum distribution (RMD) notices in the mail for qualified plans, except Roth IRA. (Heavy emphasis on “required” here.)

This is the story of one small business owner client whom we’ll call Edith. She got these notices. But she had several retirement accounts and more than enough money to live comfortably without the RMDs. She was contributing to her qualified plans and her money was growing tax-deferred. She wanted to leave the money in her accounts for her family, favorite charity, and her business to preserve her legacy. But her wishes didn’t matter to the IRS. She would have to take the withdrawals from her accounts (remember that key word “required”) or face some pretty stiff consequences.

Edith’s case isn’t unusual. We’ve encountered many of your clients in similar positions. In a 2014 Fidelity Investments study of 750,000 of its IRA customers, 68% who should have taken RMDs hadn’t done so by year’s end. Why? Common reasons cited include lack of knowledge, confusion about what to do with the money if they take it out, and waiting for the market to rebound. Also, your clients may not have access to lower risk, tax beneficial accounts; and high risk investments later in life usually are not a good idea. But there’s a great (and lesser known) alternative available to clients like Edith who want to enhance a legacy to children:

Life insurance.

On April 1 of the year after Edith was turning 70½ she would be required to take minimum distribution amounts from each of her retirement accounts or face a large tax penalty. After that, she’d have to take annual distributions by the end of every year. This applies to your clients too.

How much they’ll be required to take out will depend on a calculation based on their applicable accounts and overall balances, and their life expectancy. The IRS determines this amount and notifies the plan provider, who notifies the owner. Edith needed to take out $24,000 this year.

If she didn’t take out the RMD by the close of the calendar year, Edith faced fines of up to 50% of the amount she was supposed to withdraw. She would owe the IRS $12,000! When she did make withdrawals, her money would have been taxed as ordinary income, which would have pushed her into a higher tax bracket. Either way, she would take a loss. But her advisor helped her lessen that loss by putting her RMD in the right place: a life insurance policy.

Required minimum withdrawals can be tricky for reinvesting because -- even though they’re taxed as ordinary income -- they’re not considered earned income by the IRS. There’s also an age limit for making contributions to accounts considered retirement accounts, and if your clients reach RMD age, they’ve met the limit. This means RMDs can’t be reinvested into many tax beneficial accounts, so withdrawing the money and immediately putting it back in doesn’t work.

Edith’s advisor had cautioned her about reducing her risk as she aged, so she didn’t want to reinvest the RMDs into stocks. A lot of people choose to go with safer, more secure options like bonds, money market accounts, and mutual funds. These solutions can provide some great gains, but those gains could also create more taxable income to deal with later. That taxable income will ultimately affect your clients’ estates and heirs.

Reallocating RMDs into a permanent life insurance policy (simultaneously growing a family’s ultimate wealth and legacy, and avoiding hefty estate taxes in the future) is a great dependable option, but there are a few things to be cautious of.

Generally, people take advantage of this option one of two ways:
  • Standard Permanent Life Insurance Policy

    This is the easiest method: premiums are paid into the policy and grow on a tax-deferred basis. As long as premiums continue to be paid, this permanent life insurance will remain in effect, strategically reallocating those RMDs as they can continue to increase wealth. When the insured passes away, the beneficiary of the life insurance policy won’t have to pay taxes on the proceeds of that policy.

    However, if the policy is in your client’s name, it will be considered part of the estate and will be subject to estate tax. That means beneficiaries will have to deal with the burden of that additional tax. To avoid that monetary and emotional burden, individuals who choose this option often transfer ownership of the life insurance policy to someone else.

    But this can get tricky because the IRS states that ownership must be completely transferred. This means there can be no “incidents of ownership” at the time of death (meaning your client has no control over adding and removing beneficiaries and can’t access money from the policy). And it can't be transferred to a spouse/partner because the proceeds the spouse/partner receives would be considered part of the estate. Finally, the three-year rule requires that the policy must have been transferred more than three years prior to death; otherwise it’s considered part of the estate.

  • Irrevocable Life Insurance Trust

    These transfer rules often drive people to choose instead to put their life insurance policies in an irrevocable life insurance trust (ILIT).

    If you have clients who have received the RMD notice, they probably have IRAs. A life insurance trust is like that IRA; it’s the account that holds the investment, not an investment itself. This is an important distinction because the trust is set up under an entity name, not your clients’ name. Once the policies are in the trust, they become assets of the trust and are no longer considered your clients’ assets.

    The trust becomes a beneficiary and the entity responsible for managing funds, purchasing and holding policies, filing claims at the time of death, and making payments to surviving heirs. The trust (and these duties) is managed by a trustee. Your clients cannot be the trustee and it’s not recommended that a spouse/partner be a trustee, either. Trustees are usually a family member other than a spouse, a trusted friend, a CPA, or another financial professional.

    If your clients are considering more than one life insurance policy, it’s often easier and better to buy those policies through a trust. In the case of one policy, your clients would simply transfer ownership of the policy. Keep in mind, whatever choice your clients make, the incidents of ownership still apply (the changes must be made irrevocably).

    To keep things simple, your clients could continue purchasing policies with their allocations every year, and put those policies into a trust to limit estate tax and help carry on their legacy.

Edith is using some of the $24,000 for retirement funding and travel, but realized she had about $12,000 after-tax each year she didn’t need.

So she decided to use that $12k to pay annual premiums on a $295,000 permanent life insurance policy that will be guaranteed for her lifetime, with her kids as beneficiaries. This life insurance will pass income tax-free to the kids, while the IRA will be taxable to them at her death.

If you have clients who have received an RMD notice, the experts on our advisor services team can help you look into the options available to them. Just because they don’t need the money now doesn’t mean they can’t use it to secure their legacy in the future. Life insurance could be the best choice for your clients to make those RMDs grow their wealth beyond their life. Email and we’ll get in touch with you to start the process.


Term Life Insurance | Low-Load Universal Life (Individual & Survivorship) | No Lapse Guaranteed Univeral Life (Individual & Survivorship) | Long Term Care Insurance | Disability Insurance | Critical Care Insurance | Low-Load Variable Annuity | Immediate and Fixed Annuities | Low-Load Variable Universal Life | Hybrid Life/LTCi | Hybrid Annuity/LTCi

(We recommend low-load permanent life insurance and annuities when possible)

(Not all policy types available in all states)

For a list of current providers, visit the Advisor Tools section of our website and click on "Insurance Companies We Work With".

NAPFA ACP Garrett Planning Network NAPFA XYPN BLatinX Internship Inc. Sponsor