Most retirement planners recommend planning your savings around living to at least age 100 these days. The IRS can make that a bit difficult, though, with its required minimum distributions (RMD), which start when you turn 70½.
A lot of clients come to us looking for financial products they can use for late retirement planning that don’t require RMDs, like longevity annuities, money market accounts, and Roth IRAs. There is one area of savings they often overlook, and that is the universal life insurance policy. Universal life insurance can offer an additional benefit on top of these other accounts because it gives you funds for retirement while at the same time providing for heirs.
Retirement Options Without Required Minimum Distributions
The problem with retirement accounts and other direct retirement products is that you can’t just let them build forever as a way of turning them into a legacy plan. Once you reach the age of 70½, the IRS is going to require you start taking out a certain percentage of your retirement funds from qualified accounts, like IRAs and qualified annuities. The goal of this is to get you to deplete those accounts before you pass away.
For people who want to leave money to their heirs, their only option, when they start receiving those RMDs, is to reinvest them into something else. A lot of people choose to put those funds into money market accounts, which are a bit like savings accounts with limited check writing abilities. These accounts tend to have extremely conservative returns — in the neighborhood of 1% — meaning it’s possible they won’t be able to keep up with inflation.
Another option that doesn’t require any RMDs is the Roth IRA. The Roth IRA is an after-tax account that allows you to hold funds in the account for as long as you want with no RMDs. When you withdraw the money from a Roth IRA, you withdraw it on a tax-free basis.
You also can leave a Roth IRA to a beneficiary on a tax-free basis as long as the Roth IRA is five years old or older at the time of inheritance. A spousal beneficiary can treat the Roth IRA just like his or her own and will never have to take money out of it.
For a non-spousal beneficiary, the money can be taken in a lump sum, or it can be rolled into an inherited Roth IRA. The issue with that is that the non-spousal beneficiary will have to take RMDs by December 31 of the year he or she receives the account.
Finally, longevity annuities work for late retirement planning because they are specifically designed to create an ongoing stream of income later in life. In this type of annuity, you won’t start receiving benefits until you’re in your 80s, which helps you work around RMDs. The problem is that these are rarely transferable to family members, so even though they might be a source of income in late retirement, they won’t leave much behind for your heirs.
One final option, if you want to plan for late retirement income and have funds left behind for heirs, is to use a universal life insurance policy.
Using Universal Life Insurance for Beneficiaries and Yourself
Universal life insurance offers a unique way to provide death benefits for your heirs and income for yourself if you need it. While these policies can be used like retirement products, they aren’t retirement products, meaning that you don’t have to take RMDs.
Universal life insurance allows you to accumulate cash value on a policy. This cash value grows tax free and accumulates based on the interest rate provided in your contract, which is usually higher than that of a standard money market or savings account. Allowing a universal life policy to accumulate for 10-15 years is often enough to create a pool of funds that you can draw from, if necessary.
These funds are withdrawn not as a direct withdrawal, but instead as a loan. As a result, they are withdrawn tax free. If you pass away without paying back those amounts withdrawn, those funds are taken from the death benefit.
You’re never required to take the money out. If you don’t need the cash value, you can leave it in the policy and sometimes even use that cash value to pay premiums. The death benefit will remain in force and allow you to leave funds for your heirs. It passes on seamlessly, meaning that your heirs aren’t required to create any holding accounts or roll the funds over. Finally, the death benefit passes on tax free and bypasses probate.
Of course, there are a few small problems you could run into when using this for the purpose of creating supplemental retirement funding. The first is that, in a low interest rate environment, the cash value might not be lower than you might have planned for or hoped. That is why it might be wise to use a universal life policy with a higher return, like an indexed universal life policy. Also, if you were to allow the policy to lapse and you had a loan out on it, the withdrawn amount would be considered taxable.
But for the most part, a universal life insurance policy can be a good way to leverage funds for yourself and for your heirs without having to deal with RMDs. For more information on how you can use universal life for your late retirement planning, contact a Howard Kaye advisor by calling 800-DIE-RICH.
