Why the SECURE Act Makes Life Insurance More Attractive

Jonathan Henkels |

With the new restrictions for inherited IRAs for non-spouses due to the new SECURE Act, it may make sense to use life insurance as an estate planning tool.

With the passing of the SECURE Act last year, there is a significant change to inherited IRAs for non-spouses.  Rather than withdrawals being taken over the course of the recipient’s life, they must now be taken fully over 10 years.  This can cause creation of a higher tax burden as this money counts towards the income of each beneficiary.

There are a number of options to use when passing down money other than with an IRA.  One of these options is the use of a permanent life insurance policy.  This type of insurance policy has a death benefit as well as builds cash value while you are alive.  This money also can grow tax-free, can be used to obtain loans with no tax or interest charges (although loans not repaid reduce the overall death benefit), and the death benefit is distributed tax-free upon death.

You may ask when this might make sense to use, as opposed to keeping the money in an IRA.  If your beneficiaries are or would be in a high tax bracket upon inheriting the IRA, this may make better sense as it would allow the money you are leaving to them not count as part of their income as it would using an inherited IRA.  If the beneficiaries are in the upper tax brackets, this can be as much as 40% of the overall cash they would have inherited being lost to tax revenue rather than being retained by the beneficiaries.  In addition, the life insurance policy is not part of probate and is a much simpler way to transfer money to beneficiaries than inheritance of an investment account. 

A concrete example would be to imagine there is $100,000 you would like set aside as an inheritance within an IRA account.  Your tax rate is currently 12%.  Therefore, for every $100 you take out, $12 would be taxed against it.  Your beneficiaries are now doing well and are in the 32% tax bracket.  Therefore, they would pay $32 on that same $100 they might withdraw.  If you were to buy a life insurance policy and pay for it with the distributions from the IRA, your beneficiaries would receive the death benefit tax-free, and if there was any money still available in the IRA, they would get that as well. 

Another option is to combine the life insurance strategy with naming your favorite charity as beneficiary.  This allows the charity to receive the money tax-free.

It is important to remember that every case is different and there should be a discussion with a financial planner held before making any decisions about how you might want your estate to be distributed.  Feel free to call our office to learn whether this would make sense as a part of your overall financial plan.