Life Insurance Estate Planning – No Taxes & Financial Security

Between right now and 2045, economists estimate between $60 – $84 trillion will pass from Boomers to their children, mostly millennials.

To set the stage for that, the Millennial generation only holds about 5% of the country’s wealth. In practical terms, this generation will go from survival mode to suddenly having a boatload of money. 

Not to say that people are inherently irresponsible with money. But if you look at lottery winners (even the ones who win many, many millions), 70% go broke within 5 years, according to the National Endowment for Financial Education.

What can someone do to ensure their children inherit money responsibly and don’t decide that a large inheritance during a midlife crisis is a great opportunity to take up boat racing?

We’re going to take a look at a method affluent families use via life insurance to protect both their wealth and their children from financial temptations.

This strategy uses the same principles outlined in more detail in How to Build Wealth with Life Insurance. Read that article to see how you can set this up for yourself.

Key Takeaways

  • Using the gift exclusion, you can leverage a gift to your children for 5-10x the value
  • Help protect your children from rash decisions that often follow a large inheritance
  • Create a tax-free income stream for your children in retirement
  • You can use RMDs or annuity income distributions that are not needed elsewhere

Life Insurance Estate Planning Strategy

If you could give your child a gift and leverage it into 5-10x the amount, would you? 

What if the growth was tax-deferred without downside market risk

What if they could get tax-free distributions? And there’s no income tax or capital gains tax

There are many ways to pass on wealth to the next generation. Many strategies focus on minimizing estate taxes. Some protect the principal from unwise spending or creditors through various methods. 

Few, if any, provide income without taxes. Fewer still create financial security for family members. 

What we’ll detail below are several scenarios in which parents can use five years of gift exclusions into a leveraged life insurance estate planning strategy. That gift grows over 15 years, and then your adult children can access it for anything they want, most commonly: 

  • Retirement income
  • Home purchase
  • Paying for their children’s college education

4 Common Situations 

These are the four most common scenarios we see when families start looking at life insurance estate planning. We’ll address each one.

  • High earners
  • Business owners
  • Annuity holders
  • Unneeded Required Minimum Distributions (RMDs)

It’s not something that everyone can qualify for, so we’ll start with the four most common scenarios. 

High Earners 

High-earning parents often raise children that follow them down lucrative career paths, but not always. But treating all the children with fairness works well in this example.

Any unneeded income can be set aside to fund the premiums for five years. It creates safety nets and future retirement income streams later on in the child’s life.

Or perhaps your children are finishing college with a promising degree. But may not yet make the $200,000 a year to qualify themselves for this type of leverage. 

In a few case studies, parents setting up this policy on their 18- to 23-year-olds can result in a tax-free retirement income stream of over $345,000 every year from ages 65 – 90, still with a $1M+ death benefit at the end. 

And that’s all from 5 years of the $34,000 gift (tax-excluded for couples.)

Business Owners 

Sometimes children want to work in the family business. Other times they want nothing to do with it. Usually, this situation ends up with one or two children working in the family business and the others building their careers elsewhere. The unfortunate result is that when the business owner dies, there are too many cases in the courts of the children fighting over control of the family businesses, shares, or cash flow.

Whatever career choice your children choose, we’ve seen many business owners try to ensure fairness between their children through gifting each of them their own leveraged life insurance that they can use as income streams later on. 

Another advantage for business owners is if the cash flow is available, you can stack these policies on top of each other – one at age 25, another at age 30, another at 35, and so forth. 

Annuity Holders 

Did you know that only about 5% of annuity contract holders end up annuitizing their savings? Most simply live off the interest.

That means the principal gets paid out to the beneficiary (with a lot of variabilities depending on how the annuity was structured) and then taxed. That situation often leads back to the buying a brand new speedboat scenario.

The key here is that you can withdraw up to 10% of the principal amount without penalty in most contracts. Using that to turn around and fund this type of life insurance policy protects your income, your child(ren), and the cash.

Maybe you have an annuity that is paying out income that you don’t need. This income (for only 5 years) can be used to fund this strategy for your children.

Unneeded Required Minimum Distributions (RMDs) 

You’re required to start taking withdrawals (called Required Minimum Distributions) from your retirement accounts at a certain age. That age varies depending on your current age. The amount can vary each year, with some years waiving the RMD entirely when the economy is doing poorly.

But the rest of the time? What should you do with an RMD you have to take but don’t need?

This is one of the best ways to preserve that money you worked so hard to save and invest in the first place and pass on financial support to the next generations.

How Does Leveraged Life Insurance Estate Planning Work?

You can’t do this with any old insurance. That term policy you bought to cover the mortgage won’t work here. It takes an experienced life insurance advisor to set this up correctly.

It starts with an indexed universal life insurance policy. It needs to be one constructed specially for you to maximize the cash value accumulation. Then there is another moving part where a bank funds most of the premiums for this policy. You only put in 25%. But don’t worry, they’ll take their investment back many, many years down the line when the policy is fully funded and the cash value has had a chance to grow massively, still leaving the majority of the cash value to keep growing at the turbo-charged rate.

You put your spare funds that you want to pass along to a child into a trust set up by the bank. That funds five years of premiums. The bank matches the first five years. Then they pay for the entirety of the next five.

At year 15, the cash value is now accessible to your adult child. They can use the cash value as retirement funds, cover surprise medical expenses, or even buy (part) of that speedboat – except in this case, the majority of the funds will be protected, so they can’t blow the whole thing.

What Else Do I Need To Know? 

First, there are the qualifications. Because this strategy takes advantage of leverage to turbo-charge the cash value, you will need to qualify financially.

First, if you’re younger than 55, here’s what you need:

  • Giftor must have at least $200,000 annual income (or $3+ million net worth)
  • Giftor must provide 2 years of income verification
  • Insured must also provide 2 years of income verification
  • Cover letter if the insured does not financially qualify on their own
  • Giftor must own a Kai-Zen policy for themselves
    • If giftor is uninsurable, the above is waived but details must be included in the cover letter

If you’re greater than 55, here is the other set of qualifications.

  • Giftor must have at least $200,000 annual income (or $3+ million net worth)
  • Giftor must provide 2 years of income verification
  • Insured must also provide 2 years of income verification
  • Cover letter if the insured does not financially qualify on their own

But what about the children? Don’t they need to qualify?

No. They don’t. There is slightly less paperwork if they do qualify for their own policy.

But if they don’t? That’s okay!

Since you qualify, and the bank and insurance company are only concerned that the premiums get paid, you’ll simply need a cover letter explaining that the money is there and what your intention is. Our agents can help with this.

What’s the Catch? 

I would be lying if I said anyone could do this. It takes a level of financial clout to qualify, as mentioned above.

It also takes an insurance agent with experience to set up the policy correctly. If you, for example, were to follow the normal logic of maximizing the life insurance death benefit, you’re losing out on the cash value. 

What are other people saying about this leveraged life insurance strategy?

What are the Next Steps? 

If setting this up for your adult children sounds like a good idea, the next step is to double-check the qualifications. 

First, if you’re under 55, you’ll need your own policy. If you are looking to maximize your own tax-free retirement income plus have some help paying for long-term care, you’ll likely want this in your portfolio.

To see how this plan can benefit you, click here to estimate your benefits.

Once that’s set up, you can then set up one or more for your adult children. (Sorry, this doesn’t work for children under age 18.)

We have a website that will answer 98% of your questions about this strategy.  In order to send you an invitation to use this website, we need to enter some details about you. Click here to submit your details, and then you’ll receive a link to register for this website.

Life insurance estate planning is one of many strategies we use to help clients and their families increase their retirement income and legacy. 

If you would like a helpful analysis of your retirement plan and legacy, check out this article: How o Survive in Retirement Without Running Out of Money.