How to Reduce or Eliminate Taxes on Wealth Transfer

How to Reduce or Eliminate Taxes on Wealth Transfer

When estate planners talk about annuities and IRAs, they say those vehicles are the worst to be holding when you pass away. I generally agree with the statement. Moreover, planners focus on the estate tax and reducing the impact of it. The deferred gains in a tax-deferred product – qualified or non-qualified – has the tendency to force the gain to be taxed at the recipient’s highest marginal tax bracket.


Because those assets become taxed at the highest marginal bracket, it’s important to have plans for the tax deferral or qualified accounts in a client’s estate. Many planners should look to life insurance as a way to create the necessary capital to pay for the tax. Life insurance also provides the liquidity needed in order to pay the tax without invading the IRA.   


Other planners look to leverage the power of the stretch IRA to minimize taxes and reduce the burden of the overall tax on the beneficiaries. Unfortunately, it appears that Congress is making plans to limit the amount that can be stretched to $250,000. For the mass affluent and middle-America clientele, the loss of the stretch provision might be devastating to wealth transfer. 


One Product, Two Tax Strategies

So, how can life insurance work in conjunction with IRAs and tax-deferred vehicles like non-qualified annuities? 


  • Life insurance can be used to pay for the income tax on the transfer of wealth. Income tax brackets remain extremely high – as high as 39.6 percent on a federal rate. That doesn’t even take into consideration the state tax revenue. That can push it well over 40 percent of the gain being taxed. As I travel around the country, I don’t hear enough people talking about the income tax effect on wealth transfer. Clients and planners hide behind the exemption of the federal or state estate taxes. Unfortunately, those do not apply to income taxes. Creating liquidity to meet the demands of the income tax due the April after the death of the IRA is a smart option. Life insurance pays for the cost of the tax on discounted dollars, and it generates the cash position when people need it most. 


  • Qualified assets above those that can be stretched can be transferred to life insurance. This allows the client to turn the transfer of wealth from tax-deferred to tax-free. This can be meaningful to beneficiaries and easier to transfer outside of the estate with proper use of trusts.  


Look at your tax-deferred vehicles and identify clients who will pass along not only a big inheritance, but also a big tax bill. Talk to them about using life insurance to reduce overall costs or completely eliminate the federal income tax on the transfers of wealth. 


Winning Strategy

Life insurance can be meaningful for those with larger IRAs or accounts with tax-deferred gains. These vehicles are the worst to have in your estate on the date of death. There are strategies to eliminate or reduce the income tax.  


About the Author

Mike McGlothlin is a tireless advocate for the retirement planning industry. As executive vice president of retirement at Ash Brokerage, he heads a team providing income planning solutions focused on longevity and efficiency. He’s also a thought leader who provides guidance and assistance for advisors and broker-dealers navigating marketplace and regulatory changes. You can find a collection of his blog posts in his book, “Above the Clouds … Winning Strategies from 30,000 Feet.”