Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. For today's conversation, I am joined once again by Justin Waring, head of UBS Wealthway Strategy and Solutions, as well as retirement strategist Ainsley Carbone. traditional IRAs can be powerful retirement savings vehicles, but they may not always be the most tax-efficient asset for beneficiaries to inherit. Ainsley and Justin recently explored one strategy that may help address that challenge, using IRA distributions to fund life insurance as part of a broader legacy plan. So with that, Justin Ainsley, thank you for dropping my top of the morning, spending some time today with our listeners. To begin, perhaps Ainsley, let's start with the basics. Why do IRA assets sometimes create a less favorable inheritance outcome than people expect? Yeah, of course. Thank you, first of all, of course, Dan, for having us. But to answer your question, I think many people naturally look at their IRA assets and assume that that is roughly the amount that their beneficiaries will receive, but usually that's not the case. When beneficiaries inherit a traditional IRA, those assets generally have not been taxed yet. So as withdrawals are taken, those distributions are typically subject to ordinary income tax. On top of that, many non-spouse beneficiaries must distribute the inherited IRA assets within a 10-year period. So you have a lot of ordinary income tax distributions coming in a shorter period of time. So what happens is a significant portion of that account may actually eventually go towards taxes instead of family members or other intended beneficiaries. For many families, there comes a point where they're looking at their retirement assets and they realize, okay, well, we're probably not going to spend all of this money during our retirement years. And once that happens, part of the IRA effectively becomes a legacy asset. And at that point, that opens up a whole new set of planning opportunities and trade-offs. And so it's at that point when the planning conversation shifts from how do I generate retirement income from this asset to how do I transfer these assets as efficiently as possible. So Justin, from hearing that, it sounds like this really becomes a legacy planning discussion for some families rather than a retirement income discussion. So as families are using retirement assets as part of their legacy plan, how does the life insurance strategy work? Yeah, thank you again, Dan, for having us. At a high level, the idea is pretty straightforward rather than simply taking distributions from an IRA and then reinvesting those dollars into a taxable account, retirees may choose to use some of the after-tax proceeds from those distributions to fund a life insurance policy. And over time, this essentially converts a portion of the retirement assets from a tax-deferred account, where, as Ainsley said, the IRS owns some of the account, into a death benefit that generally goes to beneficiaries income tax-free. And so, the important point here is that it's not an all or nothing decision. Uh, you know, families can decide to keep some of the assets, IRA assets. Um, they may still reinvest the distributions into a taxable account and, uh, life insurance would just be a, you know, a component of the overall legacy plan. So one way to think about this is changing the composition of the inheritance funds So instead of heirs receiving everything from a taxable IRA that going to generate taxable income for that 10 window that Ainsley mentioned they instead are going to receive a combination of assets, which might include IRA assets, Roth IRA assets, taxable assets, and life insurance proceeds. And sort of the composition can matter a lot for the taxes that the heirs are going to pay. And it can also matter a lot when it comes to sort of the ease of managing the inheritance once it gets received. So Ainsley, what Justin just shared with us sounds like an interesting strategy, but of course it's not right for everyone. When does this strategy tend to make more sense for families? Yep, that's an important point and an important question because, like you said, it's not going to be right for everyone. Generally speaking, using IRA distributions to purchase life insurance may be a strategy worth evaluating when someone has more retirement assets than they expect to spend during their retirement years. They have a strong desire to leave assets to family, and they are concerned about the impact of future taxes on their beneficiaries. Another factor may be certainty. Investment portfolios can create substantial wealth over time, especially over longer time horizons, but they rely on market returns and compounding, whereas life insurance works differently. A life insurance policy provides a contractual death benefit, which helps to create a certain amount of predictability around the outcome for the beneficiaries. It's essentially a hedge against dying earlier than expected, which is exactly what life insurance is. If someone lives a very long life, investments have much more time to grow. They have more decades to grow. But if death occurs sooner than anticipated, the death benefit may create a larger legacy outcome than investing alone might have produced over that shorter period of time. And again, this is just exactly why insurance companies usually require you to be healthy before they actually approve an application for your life insurance. So while investments provide upside potential, life insurance may provide a stronger floor on the outcome, so more certainty. I mean, different families are going to place different values on those two objectives, so I think it just comes down to figuring out what your objectives are as a family, and then from there, figuring out what strategies are going to help you and your family meet those objectives. Now, Justin, the report mentions other planning options as well. How should investors think about life insurance compared with other strategies like Roth conversions? Yeah, it's an important question because, you know, while the IRA asset is at the heart of these planning strategies, the objectives that we're trying to address are slightly different. So when we're looking at strategies like Roth conversions, which involve paying taxes today in exchange for the possibility of future income tax-free withdrawals and tax-free growth, You know, that strategy is going to appeal to families who are trying to manage the tax bracket for their retirement income throughout retirement. And what we see usually is that families will have low tax years and high tax years in retirement. And if they only wait until RMDs begin to make distributions from their IRA, they're usually going to end up paying a higher tax rate than they needed to. So Roth conversions are an income tax strategy that can help to do Roth conversions at a lower tax bracket than would later be owed on IRA distributions So it sort of a tax arbitrage play from early retirement years versus later retirement years. And Roth conversions also just generally can help to spread taxable income out over more years, which can reduce the amount of taxes that the family pays during their lifetime, can improve the after-tax wealth that they leave to their kids, and can reduce the hassle of having to deal with IRA distributions during the 10-year window following the death of the IRA owner. So there's a couple different benefits there. A last benefit I should mention, by the way, is the widow's penalty. If you leave your IRA to your spouse when you pass away and your spouse becomes a single tax filer, that may put them into a higher tax bracket than you and they were facing when you were a married couple filing jointly. So there's another benefit there to avoid the family paying a higher tax rate because one spouse has passed away. So from an income tax perspective, Roth conversions can help. And usually we're doing Roth conversions with IRA assets that are not the RMD. And so life insurance, this strategy that we've talked about is when you've got a required minimum distribution that you're already going to get taxed on, it's coming in as income to your portfolio, and you don't need for spending. In that case, putting it towards legacy certainty and a more efficient wealth transfer for legacy purposes is also additive to your portfolio, but it's not part of the retirement income perspective. And I would say the last relevant strategy to talk about is something like philanthropy planning. So your IRA assets are pre-tax assets and allocating those towards charity can be helpful. So during your lifetime, when you're above the age of 70 and a half, you can allocate up to $111,000 per IRA to go directly to charity. And this counts towards your RMD, but it doesn't get included as taxable income for you. And so that could be one of the most effective ways to give to charity is to give pre-tax dollars so that you're avoiding paying ordinary income taxes. That could be a very tax efficient way to give to charity. And, of course, the other aspect is if you choose to name a charity as one of the IRA beneficiaries at the end of your life, you can either give to charity or to a donor-advised fund. This also would help your family avoid some income taxation as well while meeting your charitable goals. And so, in practice, what we often see is a combination of these approaches. So, some of the assets remain invested in a traditional IRA. Some get converted through Roth over time. Some distributions go towards charity and other distributions go towards life insurance. And so the question that families should ask is it's not necessarily which strategy is best, but more, you know, what's the right balance of strategies that that are going to help me accomplish my goals with the most effectively? because at the end of the day, leaving taxable IRA assets to your children is probably not the most efficient for the family in most cases. And so a balance of these approaches may help to improve outcomes versus that sort of default outcome So let finish with that idea of goals What factors should investors evaluate Ainsley and Justin before deciding whether any of these approaches make sense I would start with four questions to kind of help you figure out what your goals and objectives are. So first, do you actually need the IRA assets for future spending, or are these kind of viewed as excess assets that won't be needed for your lifetime. Second is who are your beneficiaries and what are your goals for those beneficiaries? Like Justin was mentioning, if the beneficiaries are going to be a charitable organization, you're going to want to have different approaches for those assets. Third, how important is certainty versus flexibility of the outcomes that you're looking for? And then fourth, what are the tax implications both for you and your beneficiaries? Once you're able to answer some of these questions, I think the appropriate strategy can become much clearer. And I'd also just add that, you know, this is a planning decision that's going to be specific to your family. This is not a product decision. So some families are going to prioritize maximizing the amount that they leave to their beneficiaries. Otherwise, they're going to prioritize maintaining flexibility in their plan. and still other families will want to target a balance between growth, tax efficiency, and certainty. And so that's why it's important to evaluate these choices as part of a broader financial plan and in partnership with a financial advisor, because the goal isn't necessarily to choose one strategy or another, it's to build the legacy plan that reflects your priorities and what matters most to you and your family. Well, Justin Ainsley, very informative and helpful conversation today. Thank you for dropping by the Top of the Morning podcast to share these insights with our listeners and their clients of UBS. Thank you, Dan. Thanks for having us. Thank you for tuning in. Be sure to visit UBS.com slash studios to view the entire UBS Studios suite of podcast channels along with our video offerings such as UBS Trending. You can also follow us on Instagram for content highlights at UBS Trending. UBS Studios is part of the UBS Chief Investment Office within UBS Global Wealth Management. Visit UBS.com slash CIO to view the latest research. UBS Financial Services, Inc. does not provide legal or tax advice, and this does not constitute such advice. UBS strongly recommends that persons obtain appropriate independent legal, tax, and other professional advice. Thank you.
