Burden Not Thine Heirs: Life Insurance Strategies to Mitigate Inherited IRA Tax Issues

Burden Not Thine Heirs: Life Insurance Strategies to Mitigate Inherited IRA Tax Issues

Insurance people know a thing or two.

For one thing, our client dealings reveal that people want to be remembered fondly, even when they’re gone – that is, long and truly gone.

The word ‘legacy’ in on everybody’s lips. Not just in the literal sense of assets left to heirs, but in terms of fulfilling dreams and providing joy to loved ones; security, too – often to complete strangers, via charity. It’s a noble and eternal goal, this legacy concern, simple to establish if one wishes, and just as easy to mess up. If you wonder about the latter, ask Alexander the Great.

Living in New York in post-crisis 2009, I used to walk my wife’s dog from the Upper East Side over to Central Park, so he could have a good run and upset the West Side pooch wranglers with his endless mating-dominance behavior. On the way, I liked to stop at a coffee cart for refreshment.

My favorite wheely-gig was owned by Waheed, from Kandahar, Afghanistan. Standard order: kosher bagel and café Americano. The owner, with classic Persian charm and manners, was a delightful fellow. One time, he asked to know my middle name – usually the father’s, he’d heard, and family tradition reveals all, he said. Waheed only had the one name, to the consternation of passport control and other troublesome types, so he was particularly curious.

So I told him – Alexander. A look of dismay and alarm – like my ex-wife would display when I’d utter something unbidden, like “say, I have a good idea” – flashed across his countenance. His face was a mask of unfeigned horror. Perhaps if he’d met my father, I could understand… No, it was something else. A legacy, if you will.

“Iskandar!” – he barked.

Oh, him. Alexandros ho Makedon, in Persian parlance. No relation: my people hail from Byzantium, his are mountain folk, sniff. True, postmortem he earned the appendage ho Megas, the Great. To this day, across the Near East – even in Waheed’s hometown, which is Alexander’s creation and namesake – the conquering alien tyrant rates poorly, except in terms of terror. Parents still scare their bratty ones with the words, behave, go to sleep, or Iskandar will get you.

I can use Iskandar to scare you, too, just by telling you what he did. After conquering antiquity’s greatest empire, he launched a misbegotten attempt on India, crossed a desert, settled in Babylon, recklessly drank unmixed wine in his late rival’s palace, and descended forthwith into Hades.

He did these things – all high-risk activities on the ancient actuarial tables – without a proper succession plan in place. This couldn’t happen in Byzantium.

Indeed, it shouldn’t have happened at all. He had good advisors, Aristotle among them. Alas, conquerors are know-it-alls; consultations with experts are low-agenda items. When you’re next talking to, I don’t know, Warren ho Westchester, or similarly proud clients, bring up this story.

Alexander did leave a will. At its reading, ancient chroniclers say helmets were raised for vigorous head scratching. No heir was named; instructions were limited to ‘keep on conquering and build a big pyramid for my father’s tomb, thanks,’ and other sparkling, burdensome trimmings. His princes then set about plotting and chopping up the empire. Greece once stretched all the way to India, but only for a time – all for want of an estate plan.

Imperial clients are in short supply these days, but we do have the very wealthy: million- and even billionaires. We like them, and before you cynically cry ‘for the fees’, I claim it’s something else: the complexity of their needs. Alexander was told India’s army exceeded his own tenfold, to say nothing of elephants, but he had a go (his men mutinied, but we’ll save that metaphor for another case). Keen professionals, whether through lance or actuarial algorithm, love a challenge.

Ultra-wealthy clients share a pressing concern – that’s right, legacy. The wealth of a lifetime (or several, since many of these fortunes are inherited) must be preserved. Giving it away, though – it’s not so easy. The scourge of the wealthy is hardly cheap wine – it’s that eternal pestilential foe, the taxman. We wonder whether Alexander, cowering behind his brazen shield, is even now facing him in the Underworld.

Many professionals serve HNW clients, aged mostly 50-75, who’ve amassed considerable assets to provide for a comfortable retirement. Indeed, they often have more than required. Surplus assets are frequently earmarked for heirs, and they often include that double-edged sword, a fully primed IRA account.

Traditional IRAs, as clients hopefully know, are created with pretax money. With the stretch IRA no longer available, the required minimum distributions can easily force an inheritor into a higher earnings bracket. Grateful heirs can quickly turn cranky, I find, when faced with a tax ruckus, as they used to say at a colorful company on my resume. Feel free to use this non-proprietary term in your marketing materials. It makes the point grandly.

The order of the day is an IRA maximization strategy that converts a potentially troublesome retirement account into an asset that provides deserving heirs with a useful legacy, without the specter of endless trips to the tax accountant – to say nothing of the inevitable e-payment that so delights the IRS.

Alexander famously unloosed the Gordian Knot with his sword. In our case, life insurance stands in for gleaming bronze.

Clients with complex estates can found an Irrevocable Life Insurance Trust (ILIT) to manage one or several life policies, with the death benefits assigned to chosen heirs. An ILIT works well for minor children, adults who perhaps cannot be trusted with too much money in hand, or a surviving spouse who lacks the financial knowledge needed to manage large funds. In such cases, an ILIT can make regular payments from the death benefit while maintaining the tax advantages of the life policies. Gift and estate taxes can also be mitigated by parking life policies in an ILIT.

Clients who need flexibility can opt for a life policy that includes a cash value, which provides myriad options for the future. Customers who anticipate little turmoil ahead can buy simple life products that offer the maximum death benefit possible, as limited by the usual factors of age, health and affordability.

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