Articles

Employee Benefits

IRAs and Retirement Plans

Don't Ignore Retirement Plan Insurance Opportunities

                        Estate planners attempt to structure asset transfers in a way that minimizes estate, gift, and income taxes while providing liquidity to pay taxes, if any, that may be due upon death, and to provide for the continuing financial needs of survivors.  Estate plans for business owners often are complicated by the absence of liquid assets, since wealth may be tied up in business assets or trapped in IRAs or other forms of qualified retirement plans.  Moreover, a business owner may want to avoid purchasing additional insurance which would  be included in the owner’s estate for tax purposes, or he or she may lack a tax-efficient means of paying premiums on such insurance. 


                       Retirement plans often hold substantial sums,  but generally are not considered effective estate planning tools, since plan assets are subject to income and estate taxes upon the participant’s death.  Plan distributions are subject to income tax and (possibly) penalties which make them unattractive sources of insurance premium payments.  IRAs are not allowed to invest in insurance contracts, and insurance contract investments by other types of plans are restricted.  However, it may be a mistake to ignore the possibilities of investing plan assets in insurance contracts, since careful planning may enable an owner to unlock IRA or other benefit plan dollars to purchase insurance benefits that may be excluded from the owner’s estate.          

        
                       A business owner who is still actively involved in the operations of his or her business may establish a company retirement plan into which he or she may roll over IRA balances.  Once IRA funds are inside a defined benefit plan, such as a traditional pension plan (“DB Plan”), or defined contribution plan, such as a profit sharing or 401(K) plan (“DC Plan”), funds may be invested in insurance contracts, as long as the plan document permits such an investment.  A DB Plan may not invest in contracts providing insurance exceeding 100 times projected retirement benefits and a DC Plan  may not invest more than 25% of contributions in term policies or 50% of contributions in whole life policies.  Still, this may enable a sizable amount of insurance to be purchased.  The challenge is to avoid estate taxes resulting from inclusion of insurance proceeds in the owner’s estate upon his or her death resulting from plan payment of premiums and income taxes on policy transfers out of a plan. 


                An insurance contract may be transferred from a plan by distribution or sale at a pre-determined time to avoid inclusion in the owner’s estate and related estate taxes, while also minimizing income taxes associated with the transfer.  The transfer usually is made near the end of the premium payment period, with the recipient being responsible for premium payments following the transfer.  The value of the policy will be subject to income taxes at the time of transfer. The transfer of the policy into a family limited partnership or irrevocable insurance trust may keep the value out of the owner’s estate, but subject it to gift tax at the time of the transfer.  Despite income or gift taxes arising from the policy transfer, the owner and heirs may realize substantial benefits as illustrated by the following example:


                       A 66-year-old owner with a 65-year-old spouse and $5,000,000 in an IRA rolls over $2,000,000 to a company DC Plan.  The DC Plan purchases a $6,400,000 survivorship policy, with premiums of $200,000 per year payable over five years.  In the fourth year, when the policy has a cash value of $178,732, the policy is distributed to the owner, who pays $49,809 in income taxes on the distribution, pays the final premium on the policy and transfers the policy to an irrevocable insurance trust, thereby keeping the value out of his or her estate for estate tax purposes.  At the owner’s death, heirs will receive the $6,400,000 in policy proceeds and realize a total tax benefit of $7,700,000 compared to $2,500,000 they would have received if the $2,000,000 had remained in the IRA.  

                    A complete review of the complex issues involved in using retirement plans as estate planning tools is beyond the scope of this brief discussion.  In addition, estate and tax implications and benefits will vary substantially depending upon particular circumstances.  Please contact us if you desire to explore this topic. 

Attorney to Contact

• Thomas W. Rieck
• Ronald P. Duplack