Are you prepared for the next big step of your retirement journey?


Editor’s Note: It’s important for accountants, CPAs and tax preparers to understand the strategies laid out below when working with high net-worth clients.

You are approaching retirement or maybe you have reached retirement. You have succeeded in achieving your goals. What do you do with your qualified retirement plan and IRA savings now?

The IRS is waiting for their tax revenue on your money. IRA, 401(k), 403(b), SEP, SIMPLE, Defined Benefit Plan. It’s all qualified retirement money subject to taxation upon distribution.

Qualified retirement money has the powerful advantage of being saved pre-tax and growing tax deferred. However, when the money is distributed it is 100% taxable as ordinary income. If you do not need the money and want to postpone distributions and keep the money growing you will be forced to take Required Minimum Distributions when you reach age 72.

Historically, people with large amounts of money in qualified retirement accounts typically only take their Required Minimum Distributions. They leave the remaining balance to their spouse or children. The money in the IRA will continue to grow tax-deferred until it is distributed over the beneficiary’s lifetime. This strategy is commonly referred to as a “Stretch IRA”.  The “Stretch IRA” was eliminated with the passage of the Setting Every Community Up for Retirement Enhancement Act (SECURE Act).

Effective January 1, 2020, the SECURE Act:

  • Defers the Required Minimum Distribution age to 72
  • Allows for IRA contributions past age 72
  • Eliminates the Stretch IRA. Requires beneficiaries of IRA, Roth IRA, 401(k) or other qualified retirement plans to liquidate the inherited account within 10 years with a few exceptions.

Exceptions to the 10-year liquidation requirement include beneficiaries that are disabled or chronically ill, minor children of the deceased retirement account owner, and beneficiaries not more than 10 years younger than the deceased retirement account owner. Spousal beneficiaries can still make the inherited IRA their own and take their Required Minimum Distributions according to their age and the IRS Table.

Beneficiaries other than the exceptions named above will have to liquidate the inherited retirement account by the end of the 10th calendar year following the year of the original retirement account owner’s death. This can be a catastrophic tax event. If the original retirement account owner dies after December 31, 2019, these new rules apply.

Money accumulated in a qualified retirement plan or IRA is taxable income when it is distributed, whether during your life or upon your death. Required Minimum Distributions at age 72 make sure that you cannot defer taxation indefinitely.  Under the IRS rules, every pre-tax dollar distributed from a qualified retirement plan is taxed as ordinary income. However, there is one exception. If that dollar is inside a life insurance policy and the life insurance policy is distributed from the qualified retirement plan, only the market value of the policy is taxed as ordinary income. Life insurance is the only asset that is given this unique tax treatment.

Under the IRS rules, a life insurance policy can be purchased and fully paid for within the qualified retirement plan using pre-tax dollars. In the future, the policy can be distributed from the qualified retirement plan. This distribution triggers taxation on the market value of the policy as defined in IRS Revenue Procedure 2005-25. In this Revenue Procedure the IRS provided a Safe Harbor calculation for defining market value. This calculation is referred to as the P.E.R.C. calculation. Following distribution the policy is owned personally and treated the same as any individually owned life insurance policy. The policy will provide a tax-free death benefit to beneficiaries, loans can be taken from the policy to provide tax-free income, and some policies provide tax-free benefits for use during the insured’s lifetime in the event of terminal, chronic or critical illness or injury.

A Distribution Solution Strategy

Using the tax treatment of life insurance as a qualified distribution strategy, a life insurance policy is purchased using existing accumulated pre-tax qualified retirement funds (i.e. IRA, 401(k), 403(b), defined benefit) within a 401(k) or profit sharing plan. The life insurance policy is fully paid for with the pre-tax qualified retirement money over a period of 5-7 years. After the life insurance policy is fully paid for the life insurance policy is distributed from the qualified retirement plan to the account owner. This distribution triggers taxation under the Revenue Procedure 2005-25. Care must be taken when selecting a life insurance policy to get the desired tax savings and benefits. Selecting a policy issued by a financially strong insurance carrier is critical.  With use of the proper policy, the strategy reduces the taxes on the qualified retirement account distribution. 

In the 401(k) or profit sharing plan, an individual can use the money in their account to insure themselves, their spouse or their children. The money can be split to insure multiple people such as a husband and wife. This provides flexibility to meet diverse planning needs.

This insurance distribution strategy can provide the following benefits:

  • Significantly reduce income taxes on qualified retirement plan distributions
  • Increase tax-free legacy to beneficiaries
  • Eliminate Required Minimum Distributions
  • Reduce or eliminates exposure to market risk
  • Provide tax-free living benefits (terminal, chronic or critical illness or injury)
  • Provide tax-free funds not subject to Medicare surcharges and taxation of Social Security income

There is currently $32 billion sitting in American qualified accounts. This life insurance strategy provides a tax-advantaged alternative to traditional IRAs with their growing taxation and Roth conversions subject to higher taxation. It also provides a solution for those who lost their Stretch IRA for legacy planning.  This life insurance distribution strategy can put control back in the account owner’s hands allowing them to use their money when they want and how they want.

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Mary Read CPC, QPA, CPFA is National Director of Pension and Protection Planning at Pentegra Retirement Services and partner of M & R Business Development Group. A leading authority in qualified retirement plans with more than 30 years’ experience, Mary has an extensive background in plan design and development and experience as a marketing executive, financial professional, pension analyst and pension compliance manager for an international company. Before joining, Pentegra Mary was Vice President Qualified Plan Marketing for National Life Insurance Company. National Life Insurance Company supports career and independent producers in qualified plan sales and has been dedicated to writing qualified plan business for more than 65 years. Prior to joining National Life Mary was a Pension Consultant with an actuarial consulting firm, and previously was Assistant Vice President of Marketing and Retirement Planning for MONY Life Insurance Company of New York. Mary is a frequent speaker on qualified plans and contributor to industry publications. Among her credits, she has taught pension classes across the country for major financial institutions and been a featured speaker at national meetings for the Society of Financial Service Professionals, AALU, LIMRA, MDRT and the Forum 400. Mary is the author of three books: My Business is My Main Asset. I Want to Retire. Benefiting from a Plan, 412(e)(3) Safe. Stable. Secure and How to Use the Tax Code to Get the IRS Out of Your Retirement. Mary holds the Certified Pension Consultant (CPC) and Qualified Plan Administrator (QPA) designations from the American Society of Pension Professionals and Actuaries and Qualified Plan Fiduciary Advisor (CPFA) designation from the National Association of Plan Advisors (NAPA). Mary provides CPE credit to CPAs as a NASBA National Registry of CPE Sponsor.