Buying Tax-Free Life Insurance in Retirement Plans

Dollars held in qualified plans like IRA’s, 401(k)’s, 403(b)’s and Profit Sharing Plans are subject to income taxes, netting heirs only 65-75 cents on each plan dollar. However, you may convert to non-taxable assets in just a few steps.

First, we establish a Profit Sharing Plan and transfer all or a portion of the IRA or other plan into it. The plan is a “Pre-Approved Prototype”. The IRS has established a procedure for pre-approving retirement and other plan documents to provide greater certainty to employees sponsoring such plans that the plans are tax-qualified.

Initially, you make an IRS-approved tax-free transfer to your newly formed Profit Sharing Plan. Secondly, the new plan purchases a life insurance policy with pre-tax dollars on the lives of you, if you’re single, or both you and your spouse, the so-called “second-to-die” policy, if you’re married, with a death benefit that -- depending upon the age and health of the participant and spouse -- can be five to six times greater than the value of the qualified plan. The purchase of the life insurance inside a Profit Sharing Plan is permissible by the IRS. The policy is then transferred to an Irrevocable Life Insurance Trust (ILIT) for fair market value taking the death benefit outside of your estate.

The benefits of this approach are (1) you use your qualified plan assets to pay life insurance premiums without using your gift tax exemptions, and (2) once the life insurance policy is owned by the ILIT, the death benefit is income and estate tax-free. This helps to preserve your legacy by building wealth outside of your taxable estate and also adds liquidity for your heirs.

This technique works even better for the fortunate few who may owe estate taxes, where the net value of the retirement plan can be reduced up to about 75% once estate taxes are added to income taxes. So, instead of only getting twenty-five cents on the dollar, your heirs would get the full dollar.

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