Estate Maximization with Built-In Funding
by Allan D. Gersten, CLU, CFP, ChFC

Many retired clients have over funded their lifetime retirement income needs. In other words, they have accumulated more assets or sources of income than they will ever need, whether due to thriftiness, inheritances, or employee benefit plans, such as 401(k) accounts and IRAs.
      The focus should be on pre-tax retirement vehicles that will reside in the client’s IRA. The accumulation aspects of pre-tax planning of the IRA are significant. But the estate planning potential and inflexibility make it a disaster waiting to happen. There will be a federal income tax and an estate tax combination that could quickly decimate the IRA by up to 75% of its assets.
Deferred annuities pose a similar problem due to the growing deferred taxable income. If that were not enough, a third tax, known as a generation skipping transfer tax, is imposed if the grandchildren are designated as beneficiaries.
Clients who want to leave the largest amount possible to their families may have hope in avoiding such a catastrophe with a repositioning method known as IRA maximization or annuity maximization.

      To employ this strategy, the client must be sure that they will not need the portion of the IRA or deferred annuity to be repositioned. Here is the process for implementing the IRA Annuity Max concept:
1. Invest the IRA or annuity assets designated for repositioning in a single-premium immediate annuity (SPIA), which provides a lifetime income for the client. This is particularly attractive since there are no market fluctuation risks to contend with, the income is 100% guaranteed, and the client cannot outlive the income.
2. The monthly distribution from the IRA account is all-taxable but there are no penalties if secured after age 59 1/2. The after-tax distribution from the single-premium immediate annuity IRA or single-premium immediate annuity is then used as payments for the lowest cost life insurance policy. The policy insures the client for their lifetime with a fixed cost.
3. The owner and beneficiary of the life insurance policy is the offspring of the client or it is an irrevocable life insurance trust. Either of these own-ership
structures keeps the proceeds out of the client’s estate for federal estate tax purposes. A total of $12,000 per beneficiary, per spouse, per year may be transferred to the insurance owner (irrevocable life insurance trust trustee or children) without any gift-tax consequences. This is accomplished with proper notification called “Crummey letters.”
4. The number of irrevocable life insurance trust beneficiaries dictates the gift tax exclusion allowable. If the allowable exclusions are exceeded by the insurance costs, a portion of the $1 million lifetime gift exemption can be used to make up the difference.
In summary, here are the benefits of an IRA and annuity max strategy:
• Federal income tax to IRA beneficiaries is eliminated. All federal estate tax on the IRA is eliminated. The single premium immediate annuity has no estate tax implication since it has no IRS value. Generally, it ends at death.
• There is no estate taxation for the client’s heirs: a guarantee that the life insurance proceeds will pay a certain amount certain to the beneficiaries.
• If paid to an irrevocable life insurance trust, money is protected from creditors and is distributed according to the provisions of the irrevocable life insurance trust.
• Beneficiaries can plan with an unencumbered, probate-free, tax-free inheritance.
      This estate planning strategy is not for everyone. But it can be effective in leveraging assets with life insurance that a client would not need during their lifetime – creating a larger estate for heirs.
Clients often work their whole lives to save for a rainy day or for their retirement without fully considering thoughtful estate provisions for family members.
Sometimes, clients see that they have more assets and income than what will be needed for the future, event taking into account inflationary pressures and the possibility of longer life spans.
      The best client for this approach should be reasonably healthy in order to make the cost of the insurance component viable when matching up with the cash flow from the single premium immediate annuity.
If pre-tax vehicles are not available, the estate-maximization strategy works for after-tax investments, such as CD’s and municipal bonds.
Our nation’s graying population is giving advisors an endless supply of prospects for this underutilized approach to unfunded estate planning needs.

Estate -Maximization Case Studies

Example #1: Legacy grows four times original amount: Jim, age 68 and Melissa, age 62, non-smoker preferred in a 35% income tax bracket
They have a $5 million estate growing at 5% after tax. They have one deferred annuity with a current value of $750,000 and a basis of $400,000, growing at 5.5%. There are three children and one grandchild. The couple inherited some money and do not need the deferred annuity forretirement income.
      We took withdrawals from the annuity ($40,488 pre-tax and $26,317 after-tax) and gift the after-tax distributions to an irrevocable life insurance trust. The irrevocable life insurance trust purchases a guaranteed premium survivorship life insurance policy with a face amount of $2,452,716. The annual premium is $26,317, which is equal to the after-tax distribution.
      Jim and Melissa were able to decrease their taxable estate, increase the amount to their heirs, and leave a legacy that’s more than four times greater than if they had done no planning.
Example #2: additional income plus maximized amount for heirs: Joanne, age 76, preferred non-smoker, is retired and a widow with two children and two grandchildren.
      She owns a $500,000 CD that generates an annual income of $22,000 (4.4%). She wants to increase her income and she’s interested in maximizing what she transfers to her heirs.
      We liquidated the CD and purchased an SPIA with an annual after-tax income of $46,639. She will make annual exclusion gifts of $15,810 to the irrevocable life insurance trust, which will be allocated to a life insurance premium. The balance and $30,830 becomes income. The trustee of the irrevocable life insurance trust purchases a guaranteed premium life insurance policy with a death benefit of $500,000.
      Her income is guaranteed for life and the additional annual income after the insurance premium is paid is $8,830. She has a $105,960 increase in cumulative income until life expectancy (12 years). There is an estate tax savings of $250,000, compared to retaining the CD.
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Allan D. Gersten, CLU, CFP, ChFC, is chairman of First American InsuranceUnderwriters, an insurance brokerage that specializes in life insurance, long-term-care, and annuity products. Gersten has been in life insurance sales since 1969. He can be reached at 800-444-8715 oragersten@faiuonline.com.