Pension Rescue

Overview
It has been my experience that many affluent people who have accumulated alot of wealth within retirement plans including IRAs really don’t need that money to live on in retirement because they have a substantial amount of investment or earned income outside of the qualified plan. As a practical matter, these taxpayers would never withdrawal any money from these funds if it weren’t for the Required Minimum Distribution (RMD) requirements and hefty 50 percent penalty on any under-payment of the RMD.

The problem is that the federal government aka the Feds, have a problem with wealthy people deferring income indefinitely. A combination of factors descend upon the taxpayer forcing him to take distributions – (1) RMDs at age 70 1/2 (2) A 50 percent penalty on the different between the RMD level and distributions (3) Required distributions within five years of the taxpayer’s death or over the life expectancy of the beneficiary(ies). On top of that, add federal estate taxation. The combination of income and estate taxes could impose a “double whammy” of 70-80 percent.

The question is if there is a better way to deal with the problem once you realize that you don’t need this money to live on but instead wanted to preserve and transfer wealth to your family (including the family dog!). The Pension Rescue Strategy is one method to redirect and redistribute the wealth in tax-deferred plans – retirement – and leverage those dollars using life insurance. The Plan allows the participant to purchase life insurance within the Plan and distribute the life insurance policy at a discount for tax purposes.

The Pension Rescue Plan works as follows – (1) The owner of a large IRA does a rollover of an existing IRA into a new profit sharing plan within a new family LLC or LP (limited partnership). (2) The profits sharing rules provide for a “seasoned money” exception that would allow the entire account balance to be invested into a life insurance policy within the Plan. (3) The trustee of the Plan purchases single life coverage on the life of the participant. The policy is funded over several years – say five – and then distributed or sold to the participant. The tax discount is 40-50 percent in the example. The tulimate death benefit is income tax free and possibly estate tax free. Policy distributions can be taken as tax-free distributions. Some policies have the potential to discount the value at the time of the distributions by a larger amount – 60-70 percent.

A few life insurers have designed specialty life insurance products that have low valuations for tax purposes. For example, Grandpa, age 65, has an IRA with $2 million in it. He creates a family LLC which adopts a new profit sharing plan. He does a rollover of the entire IRA balance into the new profit sharing plan. The plan trustee (Grandpa) purchases a indexed universal life insurance policy with premiums of $400k per year for five years. The policy’s death benefit is $6.5 million. The cumulative premiums are $2 million. The trustee distributes the policy to Grandpa. The value for tax purposes is $1.2 million. The taxpayer pays taxes on this amount and can take a policy loan to pay the tax liability. The death benefit is income tax free.

Summary
A number of taxpayers find themselves in this position – enviable I might add. Too much retirement income that you don’t need and would rather continue to defer. The Pension Resuce Strategy reduces the ultimate level of taxation and leverages the benefit for the family even further by using a tax-advantaged vehicle – life insurance. You may not like life insurance or life insurance agents but you probably don’t like MDs or lawyers either. However, we you need what they offer, you need to use the best tools available.

Before you go, please remember to count your blessings today.

About gerrynowotny

I am a tax and estate planning attorney with a JD and LL.M in estate planning from the Univesity of Miami School of Law. I have worked in the life insurance industry for twenty three years and the last eleven in private placement life insurance.
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