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How to Use IRA's and Insurance in Your
Estate Plan
How can life insurance be used in
my estate plan?
Life insurance is one of the most flexible estate planning
tools available. Life insurance death benefits provide
a ready source of cash to your beneficiaries when they
need it most. There are numerous ways to use life insurance
as part of a comprehensive estate plan. Here are a few
estate planning objectives that can be accomplished with
life insurance:
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Insurance can assure financial protection for the
family in the event of the insured's death by providing
funds for the widow's support, the children's education,
or satisfaction of a mortgage on the family residence.
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Insurance can be used to create an estate for an individual
which otherwise would not exist.
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Insurance can assure sufficient liquidity to satisfy
federal estate taxes and other expenses incurred by
reason of the insured's death.
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Insurance on the life of the spouse with the smaller
projected gross estate may protect against an increase
in estate taxes payable by allowing the surviving spouse
to utilize the marital deduction or applicable exemption
amount.
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Since insurance proceeds need not be payable to the
decedent's estate, transmission of wealth to the designated
beneficiaries may be accomplished with a minimum of
probate and administrative expenses.
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Distributions from an insurance policy are generally
regarded as a tax-free return of capital. Although
any interest earned would be taxable income, the immediate
purchase of additional insurance with dividends or
interest precludes the accumulation of interest and
the imposition of any income tax.
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The use of irrevocable life insurance trusts may significantly
reduce the decedent's gross estate, while at the same
time transmitting wealth to the decedent's beneficiaries.
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Life insurance is well adapted to a program of lifetime
gifts.
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Life insurance proceeds payable to the decedent's
spouse qualify for the estate tax marital deduction.
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Insurance plays a key role in
planning for business interests. Insuring a "key-man" or
using insurance to fund buy-sell agreements, stock
redemption agreements, pension and profit-sharing
plans, and other employee benefits are common.
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A professional person may carry sufficient insurance
so that, when the insurance proceeds and other property
are combined, the person's family will receive approximately
the same level of income after the person's death that
they received during the person's lifetime. To accomplish
this objective, it has been suggested that insurance
on a corporate executive should be four to six times
a person's annual salary, while the self-employed professional
requires insurance protection equal to seven or eight
times their annual net earnings.
Who should be the beneficiary of my life insurance?
The beneficiary of your life insurance can be family member,
business entity, business associate, charitable organization,
estate, or trust - or some combination of these beneficiaries.
The owner of the policy must have an insurable interest
in the insured person. But a beneficiary can be just about
any identifiable person or entity that the owner of the
policy selects.
The key to naming a life insurance beneficiary is to make
sure that the proceeds of the policy go where they are
intended. This is not always a simple matter. Many people
mistakenly assume that a will or trust automatically changes
their life insurance beneficiaries. Another common mistake
is to name an individual beneficiary with the expectation
that the beneficiary will share the insurance proceeds
with other persons as the policy owner intended. Most importantly,
many parents name their minor children as life insurance
beneficiaries without realizing that the children may inherit
a small fortune in cash when they turn 18 years old. All
of these problems can be easily resolved with proper estate
planning.
Who should be the beneficiary of my IRA or 401(k)?
Understanding your options when naming a beneficiary of
tax-deferred retirement plans can be confusing. A complete
discussion of this topic is well beyond the scope of this
FAQ. However, we can summarize your IRA options here.
To begin, you must first understand
two important concepts: Required Beginning Date ("RBD") and Required Minimum Distribution
("RMD"). The RMD is the smallest amount that an account
owner is required to withdraw annually from their tax-deferred
account. The account owner's RBD is April 1st of the next
year after they attain age 70 1/2.
A beneficiary may be a spouse, non-spouse, estate, or
trust. The options available to each type beneficiary will
vary depending upon whether the account owner dies before
or after their RBD. The tax consequences will also vary
depending upon the selection made. The following options
are available to each type of beneficiary:
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Spouse
After the RBD:
1. Lump Sum Distribution
2. Rollover
3. Distributions Over Life
Prior to the RBD:
1. Lump Sum Distribution
2. 5-Year Deferral
3. Rollover
4. Distributions Over Life
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Non-Spouse
After the RBD:
1. Lump Sum Distribution
2. Distributions Over Life
Prior to the RBD:
1. Lump Sum Distribution
2. 5-Year Deferral
3. Distributions Over Life [multiple beneficiaries may elect to use separate
accounts for their respective share]
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Estate
After the RBD:
1. Lump Sum Distribution
2. Distributions Over Remaining Life Expectancy of the Account Owner
Prior to the RBD:
1. Lump Sum Distribution
2. 5-Year Deferral
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Trust [The trust must meet four IRS requirements to
defer taxation of IRA]
After the RBD:
1. Lump Sum Distribution
2. Distributions Over Life Based on the Life of the Oldest Beneficiary
Prior to the RBD:
1. Lump Sum Distribution
2. 5-Year Deferral
3. Distributions Over Life Based on the Life of the Oldest Beneficiary
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