Changing Tax-Deferred Retirement Plans to Life Insurance to Save Income Tax and Estate Tax

Assume that an older, wealthy widow(er)or divorced individual contains a substantial quantity in tax-deferred retirement plans like defined contribution pension plans, 401k plans, 403b plans, and traditional IRAs. The widow(er) needs to leave the retirement plans to their children.

The problem is that when the kids inherit the tax-deferred retirement plans and take distributions from them, the distributions are fully taxable to the children. The retirement plans are income in respect of a decedent (known as IRD), which is taxable. Additionally, the balances within the retirement plans are fully included in the decedent's gross estate for estate tax purposes.

If the individual were married rather than being a widow(er)or a divorced individual, sometimes the individual would wish to leave the cash in the retirement plans to his or her spouse. In that case, the surviving spouse might transfer the cash into their own IRA and treat the account as their own. The surviving spouse would avoid income tax on the cash in the decedent's tax-deferred retirement plans. The bequest would also qualify for the unlimited marital deduction for estate tax purposes.

Is there any approach to attain the parent's goal of having enough cash to pay living expenses and yet leave a smart inheritance to the kids? The answer is yes if the older, wealthy parent is insurable forever insurance purposes.

Here is how the solution would work. The parent obtains a life insurance policy large enough to replace the balances in all the tax-deferred retirement plans. But, the parent is not the owner of the life insurance. The parent forms an irrevocable life insurance trust that features a "Crummey Powers" clause, and the irrevocable life insurance trust owns the life insurance policy. This technique will keep the value of the life insurance out of the decedent's gross estate.

A "Crummey Powers" clause gets its name from a court case. It has to try and do with whether a gift is subject to gift tax. Gifts that are but the annual exclusion amount are exempt from gift tax as long as the gift is a gift interest in property. A "Crummey Powers" clause permits the beneficiary of a life insurance trust the correct to withdraw gifts made to the trust that the donor intends to pay for keeps insurance premiums. As long because the beneficiary has the proper to withdraw the donation under the "Crummey Powers" clause, it's a present of a gift interest in property.

Assume that the beneficiary does not exercise the right to withdraw the donation. The irrevocable life insurance trust will use the donation by the parent to pay the premiums on the life insurance.

Where will the parent obtain the money to donate the cash to the trust to pay the life insurance premiums? The parent converts the balances within the retirement plans into a life annuity. Thus, the parent receives payments for life and uses part of them to pay the insurance premiums through the trust. At the parent's death, the annuity is value zero. Therefore, the kids do not have any income in respect of a decedent. Nothing from the annuity is included in the gross estate.

The life insurance company pays the kids the proceeds of the life insurance policy. The proceeds of life insurance on account of the death of the insured don't seem to be subject to income tax. They are not subject to estate tax as a result of the decedent failed to own the policy.

This plan allows the parent to own an income stream during life from the annuity. The annuity payments would be totally taxable unless the individual has any basis in the annuity. The individual can want to use alternative income tax designing techniques to reduce the income tax ensuing from the annuity payments.

This strategy converts amounts that will be subject to income tax and estate tax to amounts that aren't subject to income tax or estate tax within the hands of the children. This strategy needs the services of a tax advisor, an attorney, and a life insurance agent. All of them must be competent and exercise nice care in implementing the strategy. But, if done correctly, this strategy can end in substantial tax savings. It additionally provides the parent more hope knowing that the youngsters can not need to pay taxes on the life insurance.

Joan Sophie has been writing articles online for nearly 2 years now. Not only does this author specialize in Life Annuities, you can also check out his latest website about:
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