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Use of Life Insurance to Protect IRA Assets

By Marvin Rotenberg, IRA Technical Expert

Time to get technical...

Life insurance is not only be the single biggest benefit in the tax code, but it is also the most cost-effective way to protect a large IRA. If set up correctly, life insurance proceeds (death benefits) could come into the estate sans estate and income tax.

Life insurance premiums should be paid by the beneficiaries or by the trustee of an irrevocable life insurance trust so that life insurance proceeds will be estate and income tax free. After the death of the IRA owner, the life insurance proceeds could be used to pay estate tax so that the IRA does not have to be used for that purpose. All money withdrawn from IRAs will first incur income tax. The idea is to keep as much as possible (or all) of the IRA money intact at death so that the maximum amount can be stretched by beneficiaries. Having enough insurance money available to cover the estimated estate tax will avoid having to invade the IRA to pay the tax.

What if, however, there is no estate tax? This is not an option you can plan on. You should not assume that there would not be an estate tax. Insurance policies should also not be canceled because you think the estate tax will be repealed. If insurance is not purchased and it turns out that there is an estate tax, which is very likely, you may no longer be insurable or if you qualify, it may be more expensive.

Life insurance is a valuable asset, especially for older individuals. No one can be confident that the estate tax will be repealed. However, if there is no estate tax you may become subject to a capital gains tax in which the insurance proceeds would provide the cash. In addition, life insurance can also be used simply to create wealth or replace wealth used to fund vehicles such as charitable remainder trusts. And if you don’t have a retirement account, the life insurance can be a pension alternative providing beneficiaries a tax-free stream of cash for the rest of their lives.

There are plenty of other uses of life insurance but, needless to say, tax-free cash is always the best source of money and also solves lots of non-tax problems.


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