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Is Insurance An Option If IRA's Are Capped?

Roger Wohlner

An recent article in Investment News, an industry publication, looks at a the current proposal to cap the value of IRA accounts at $3 million, and how the possibility of such a rule could be a potential boon for life insurance as an alternative to IRA accounts. It's an interesting angle.

As one who is often pretty cynical towards the life insurance industry I tend look at "new and better ways" to sell policies with a jaundiced eye. The article looked at this from two perspectives.

An alternative to the inherited IRA.

I've had several clients who have been the recipients of inherited IRAs (also known as "stretch IRAs" and have this set-up for several clients for their adult children. An inherited IRA allows the account holder to pass their IRA account to one or more beneficiaries who can then manage the account as their own with some restrictions. They cannot comingle the account with other IRAs for example. If the deceased was taking required distributions from the account, the beneficiary must continue to take annual required distributions as well. The advantage, however, is that assuming the beneficiary is younger he or she can take the distributions based on their age which should result in a smaller distribution and allow the account to potentially grow over time.

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The article indicated that for those with large enough IRAs (estimated to be only 5 percent of the population) the better course of action might be to withdraw money from the IRA, pay taxes, and purchase life insurance as a way to distribute their wealth to their beneficiaries.

If it's set up correctly, life insurance can be a very effective estate planning tool. However before going this route the level of income taxes that would need to be paid up-front needs to be considered as well. The time value of money dictates that dollars spent on taxes today needs to be compared to any projected tax savings (likely estate tax savings) down the road. Also with any type of life insurance purchase, it is vital to ensure that the policy is appropriate for your needs.

As an alternative retirement savings vehicle.

Certain types of cash value life insurance have long been touted by insurance sales reps as an alternative retirement savings option. In principle, business owners or other highly paid professionals can contribute to a certain types of cash value policies with an investment component. Assuming a certain level of premium payments and expected investment results for a number of years once the policy holder retires they would be able to borrow against the policy's cash value tax-free. Sounds like a great plan, but here are a few of the potential glitches:

--Underperformance of the investment component.

--Failure of the policyholder to sufficiently fund the policy via premium payments.

--Withdrawing too much of the policy's cash value can result in a nasty tax surprise.

--High costs, as these policies are generally a very expensive way to invest compared to more traditional options.

If this IRA cap is enacted I can only imagine the increased sales effort by the life insurance industry to tout these types of policies as alternative retirement savings vehicles.

My point here is not to bash life insurance as a potential solution. Rather, I caution anyone looking at insurance in either case to fully understand what they are buying, the underlying expenses, and to be sure to look at all alternatives in the event that an IRA cap is actually enacted.

Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides financial planning and investment advice to individual clients, 401(k) plan sponsors and participants, foundations, and endowments. Roger is active on both Twitter (@rwohlner) and LinkedIn. Check out Roger's popular blog The Chicago Financial Planner where he writes about issues concerning financial planning, investments, and retirement plans.

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