September is Life Insurance Awareness Month, making it the perfect time to explore advanced strategies that maximize value for your clients. Life insurance not only provides vital protection for families and businesses but also offers a tax-efficient solution for legacy planning. For families relying on tax-deferred accounts like 401(k)s and traditional IRAs, life insurance can be instrumental in preserving wealth and ensuring a smooth transfer to the next generation.
The Challenge: The 10-Year Rule Reduces Transferred IRA Wealth
IRAs are effective tax-deferred vehicles for accumulating retirement savings—but they are a less effective legacy tool now than they used to be. In 2019, the SECURE Act greatly curtailed the stretch IRA by introducing the 10-year rule, which forces most nonspousal beneficiaries to deplete inherited IRAs within a decade. For clients looking for efficient wealth transfer, this presents a number of issues:
• The rigid 10-year timeline means the inherited IRA funds have limited time to grow tax deferred.
• Accelerated taxable withdrawals erode the inheritance.
• The required withdrawals can bump heirs into higher tax brackets, increase Medicare premiums, and trigger the NII tax—a tax burden that increases if the IRA owner had already reached RMD age before death.
• The IRA owner has no control over how the beneficiary uses the funds once they are withdrawn, creating the possibility that the inheritance could be spent down quickly rather than preserved as a lasting legacy.
Life Insurance: A Tax-Smart Legacy Solution
When it comes to legacy planning, life insurance can be a powerful alternative to inherited IRAs. Its tax-free death benefit, flexible payout options, and potential for greater control often make it a compelling choice, provided the client’s health, cash flow, and overall plan support the strategy.
Unlike inherited IRAs, life insurance proceeds are generally income tax free, ensuring your client’s legacy remains intact. In addition, beneficiaries receive the funds without withdrawal schedules or government mandates, meaning the inheritance can be timed and managed according to family needs instead of IRS rules.
By repositioning a portion of IRA assets into a properly structured life insurance policy—often funded via systematic withdrawals—clients can convert a fully taxable asset into a tax-free legacy, increasing the after-tax wealth they pass on. By using an irrevocable life insurance trust (ILIT), clients gain even greater control through the ability to dictate distribution terms, shield assets from creditors, and provide for multiple generations.
Turning Awareness into Action
Producers who raise this issue now can position themselves as proactive problem solvers—especially while Life Insurance Awareness Month keeps the topic top of mind.
1. Identify the opportunity.
Most clients don’t realize how heavily inherited IRAs are taxed. You can help them uncover opportunities for more efficient legacy planning. Review each client’s portfolio for large IRAs or other tax-deferred accounts, then ask questions like:
• Have you considered the tax implications for your children when they inherit your traditional IRA or 401(k)?
• Are you aware of the 10-year rule and how it might impact the net amount beneficiaries receive?
2. Quantify the difference.
Use concrete numbers to illustrate the advantage of a life insurance policy on a net inheritance.
• Example A (Inherited IRA): $1,000,000 gross value – $350,000 (35% tax) = $650,000 net inheritance.
• Example B (Life insurance): $1,000,000 death benefit – $0 tax = $1,000,000 net inheritance.
The “recovered” $350,000 that otherwise would have been lost to taxes makes the financial advantage of life insurance clear, tangible, and memorable.
By running additional, targeted illustrations for comparison purposes, you can show how funds from an IRA can be used to pay the annual premiums on a life insurance policy designed as the primary inheritance. This type of illustration clearly demonstrates how life insurance can preserve wealth and provide flexibility for heirs.
3. Consider a strategic conversion.
Clients who are in a lower tax bracket now than their beneficiaries will be at the time of inheritance, as well as those with sufficient liquid assets, may benefit from strategically repositioning funds from tax-deferred accounts into a life insurance policy. This can be accomplished by taking taxable systematic withdrawals from the IRA to pay the premiums, converting a fully taxable account into a tax-free legacy.
Of course, a life insurance strategy may not be suitable for everyone, particularly those who are not insurable due to health reasons or who may find the burden of paying annual premiums undesirable. In such cases, clients may want to explore other options, such as strategic Roth conversions.
Help Strengthen Legacies with Strategic Life Insurance Solutions
While life insurance can be a powerful addition to legacy planning, suitability matters. It’s important to evaluate a client’s health, liquidity, and overall retirement needs. For the right clients, though, September’s Life Insurance Awareness Month is the ideal moment to spotlight the possible integration of life insurance into retirement and estate plans. Your guidance can help clients preserve wealth and cement their legacy, strengthening both their families’ future and your advisory relationship.
