Death of stretch IRAs would boost life insurance / Tax benefits come to the fore if inherited retirement accounts get the ax

Darla Mercado for InvestmentNews.com writes:   Life insurance-based retirement strategies will look even more appealing if President Barack Obama's pitch to cap IRAs at $3 million becomes a reality.  Curbing growth of individual retirement accounts is expected to be in Mr. Obama's budget proposal, which will be released tomorrow. According to Bloomberg, the plan proposes that funds inside of a tax-preferred retirement account could not generate more than $205,000 in annual retirement income, pegging the maximum value of the IRA at about $3 million.  There isn't any word yet on how this provision would apply to Roth IRAs — which could become more popular if they are left untouched — or how amounts over the $3 million limit would be treated. 

However, experts view the move as deterring the use of inherited, or stretch, IRAs, which allow beneficiaries to extend the required minimum distribution over the course of that individual's life expectancy. As a result, the corpus of the IRA is preserved even longer and has more time to grow tax-deferred.

“I think eliminating stretch IRAs is what they're getting at, and they want to go back to saying that all the money has to be paid out within a few years after death,” said Ed Slott, an IRA distribution expert.

It's too early to tell where the proposal will go, but advisers and tax-planning experts believe that life insurance and other strategies may become more popular should the $3 million limit come to pass. 

Clients with large IRA balances could consider making a withdrawal, paying any applicable taxes and using those proceeds to buy a life insurance policy.
Retirement plan assets are “bad assets” in terms of estate-planning vehicles. Beneficiaries could start making withdrawals and end up stuck with income taxes. Meanwhile, life insurance pays out to beneficiaries free of income tax — and if it's structured in an irrevocable trust, it could pass through free of estate taxes.

“You are converting a bad asset to a good one,” said Jeremiah W. Doyle IV, an estate-planning strategist for BNY Mellon Wealth Management.
As far as coming up with supplemental retirement income vehicles for ultrahigh-net-worth individuals, cash value life insurance could also be a reasonable savings alternative because it grows tax-deferred, noted Matt Klein, managing partner at Matauro LLC, which specializes in life insurance planning. 

Universal life insurance, variable or indexed, could be positioned so that premium dollars are largely going toward cash accumulation. In this context, Mr. Klein noted, the death benefit isn't the sole purpose of the policy. Rather, it's the tax-deferred growth capability of the policy and the fact that clients can take tax-free withdrawals from the cash value to help fund costs in retirement.
Still, there is some risk in using these policies. For instance, during the market downturn in 2008, variable insurance policies took a beating because their underlying investments tanked. People who had optimistic illustrations that depicted strong market performance were blindsided when they ended up with policies with dwindling cash values that had to be propped up with even more premiums.

Any strategy that positions life insurance as a retirement savings and income vehicle needs to be closely monitored on a regular basis, Mr. Klein warned.
Further, this is more of a tax diversification play for retirement income, and it should be considered only part of the client's overall strategy.

“The trick is to make sure everything is healthy on an annual basis,” Mr. Klein said. “It's like if you bought a gremlin: It's the coolest thing in the world — if you take care of it.”
Should the $3 million limit become a reality, there are also some strategies for plan sponsors to help boost supplemental savings. 

Nonqualified plans could be a way to increase savings for highly compensated workers, too. Such concepts include supplemental compensation plans, which allow the employer to finance the worker's supplemental savings, and the death-benefit-only plan, in which the employer pays a benefit to the worker's beneficiary if the employee dies. 

These plans are already used in situations where employees earn so much money that they could save beyond the $17,500 annual limit in their 401(k) and the $5,500 limit for IRAs.
Employers typically use corporate-owned life insurance on the lives of these key employees to help fund the cost of providing these nonqualified benefits.
Still, nonqualified plans aren't available to all employers. Smaller businesses, such as S corporations and limited liability companies, might find this prohibitively costly to set up.