How A Couple Turned an Unneeded RMD Into Over $9 Million

In this case study for gifting a leveraged life insurance policy, we’re looking at how one couple took their required distributions from their retirement policies and found a tax-efficient way to gift it to their grandchildren. They chose this over the alternative of reinvesting and paying more taxes later. 

If you aren’t familiar with the mechanics of a Kai-Zen policy or how it works, we recommend starting with this article Life Insurance Estate Planning with No Taxes.

If you have any questions or want an illustration of what your situation may look like, give us a call at (888) 905-0333. Each policy is uniquely tailored to the needs and wishes of the family. 

$200,000 in Unneeded Required Minimum Distributions

This case was a little outside the norm for gifting a Kai-Zen policy. 

In this case study, we had a couple (both aged 75) who wanted to set up meaningful gifts for their grandchildren. The IRS required them to take the Required Minimum Distributions from their retirement accounts for the last several years. 

The government wanted the taxes on it. There was no way around it. 

They already had set up assets in a trust for both their children. Then they set up another one for their grandchildren. 

But they didn’t have any use for this extra money they had to take as income. So they asked if it were possible to set up a cash-accumulation-focused life insurance policy (like the ones they had for themselves) for their grandchildren. 

Then, the grandchildren could go on to use this money (after the 15-year cash value build-up) for whatever they wished, such as: 

• Supplemental income stream
• First-time home purchase
• College funding for any future children (the gifting couple’s great-grandchildren)

The four adult grandchildren didn’t qualify on their own. 

This was a tricky case because the grandparents were skipping their own children. This meant some extra explanations to the underwriters. We had to show that there was a trust set up for the children already. Then show there was another provision for more assets set aside for the grandchildren. 

Since these provisions were already in place and both generations (Gen 2 and Gen 3) were getting assets from Gen 1, the underwriters were happy, and the policies were allowed to proceed. 

The trick here is that because it’s life insurance, it needs to protect wealth rather than create it. 

Because Gen 1 had already put provisions into place for Gen 3 (the grandchildren) to inherit much of their wealth, that satisfied the requirements for the life insurance on the non-qualifying grandchildren. 

Here’s an average of what these policies looked like using the 21-year-old grandson in great health. 

An unneeded Required Minimum Distribution from the couple’s retirement accounts allowed them to gift $34,000 a year tax-free to each of the four grandchildren or $136,000 a year for all four of them for five years. 

If these grandchildren left the cash to grow until retirement age, they could take a non-taxable income of $356,000 a year every year until they were 90 and still have over $2 million to pass on to their children via the death benefit. 

Not too bad, right? 

How Does This Strategy Work?

You can give up to $34,000 a year (as a couple or $17,000 for one person) without tax penalties in 2023. Each year the number usually increases a little bit.

When most people have an RMD they don’t need, they’ll take the money and reinvest it. A good plan, but that comes with more taxes. Depending on the type of qualified retirement plan, the RMDs are taxed as income. 

Then you reinvest that money and get to pay more taxes, capital gains, and otherwise. 

Turning an unneeded RMD into a gift for this type of insurance policy on your children or grandchildren creates an income stream that isn’t taxable. Plus, it tends to have a fantastic internal rate of return. 

Qualifications

To gift a Kai-Zen policy to a child or grandchild, you’ll need to have a policy of your own first. If you’re uninsurable, that’s okay too. It just needs to be included in the cover letter to the underwriter. 

Here are the specifics:

If you’re younger than 55:

• 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

You’re greater than 55:

• 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

Your children or grandchildren don’t need to qualify on their own. 

How Does The Cash Accumulation Get Such Good Returns?

Great question. 

We cover that in depth in How to Build Life Insurance with Leverage. 

The short version is that banks like reliable investments. The type of life insurance contract has built its provisions to avoid losing money. You fund 25% of the premiums, and a bank funds the other 75%. 

After 15 years, the leveraged cash value grows – especially by not taking the hits of bad years in the stock market. Then the bank takes back its investment plus a small percentage. You get the rest. 

Next Steps

Each policy is customized for the giftor and giftee because each scenario has unique elements. It would also be wise to read through the mechanics of how a leveraged life insurance policy works by clicking the link in the section above. 

If this sounds like a good idea and you want to see a full proposal and illustration like the one pictured for the grandchild above, give us a call at (888) 905-0333.