inheritance

How to Pre-Fund a Legacy So You Can Enjoy Your Retirement Guilt-Free

If you want to ensure your kids will get the inheritance you had in mind for them — and you want to be able to spend the rest of your money on yourselves in retirement without worry — here’s one way to do that.

On June 18, 1971, at the age of 27, Fred Smith used his $4 million inheritance to start Federal Express. Today, FedEx is a multibillion-dollar company. Mr. Smith delivered on his inheritance. Mr. Smith’s story got me thinking about my kids and their future, albeit much more humble circumstances.

I have three young children. I wonder if I could I leave behind a little something for them like Mr. Smith’s parents did? I hope so. However, there’s a chance I may use up my savings in retirement. What if I wanted a little more certainty? What if I could pre-fund and guarantee my kids an inheritance? After all, I save for my kids’ college, and I save for my retirement, why is saving for an inheritance any different?

It’s not that I want to make my kids rich. Instead, I want to give them a chance to compete with families like that of Fred Smith’s. I also know if I can save for and guarantee my kids’ inheritance, I won’t have to worry about it later on. If we plan correctly, my wife and I could spend every dollar on ourselves in retirement, zeroing out our bank account. We could do this if we knew we already planned for and guaranteed our kids a tax-free $1 million inheritance.

 So, how do we do it?

Instant estate

The simplest, surest and most tax-efficient way to create an immediate inheritance for the next generation is by using life insurance. Here’s how it works.

If you give your child a check for $10,000 or $15,000 that’s nice, but that’s not a game changer. It may help with a wedding or a new car. It may be spent on bills. If we want truly transformational change, to give our kids the opportunity to do something big in life, we need to think big.

I work with a 65-year-old couple in Florida. They have enough money to live on but wanted to make sure they left something for the next generation. They want to leave their kids and grandkids $1 million total. At their age, the annual outlay for a $1 million life insurance policy is about $14,000 a year. The policy is guaranteed till their age 120.* This is not term life insurance: That doesn’t last that long. If they both pass at age 90, the return on their life insurance policy is a 6.64% tax-free rate of return. Tax-free because a life insurance death is income tax-free. They would have to earn 9.22% in a taxable investment, assuming a 28% federal and state combined tax rate. Not bad.

For my family, I am a little younger, 43, and looking at a life insurance policy that costs $5,000 a year for 30 years with a $1 million death benefit guaranteed to age 120*. At age 86, that’s a 6.13% tax-free rate of return, again assuming combined federal and state 28% tax rate. This means I’d have to earn about 8.51% before taxes to get that same $1 million**. That might be possible in an all-stock portfolio, but there are no guarantees in the stock market, plus there are taxes to consider in all stock portfolio.

A life insurance death benefit is income tax-free. Can’t say that about an IRA or 401(k). Both of those get eaten up by income taxes. Not to mention, there are several bills on the hill calling for the elimination of the step-up-in-basis rule, with some exclusions. That change doesn’t bode well for large stock inheritances, but it does favor life insurance, since the death benefit is income-tax free.

True, the kids will have to wait until Mom and Dad pass to receive the life insurance inheritance, that is the trade-off.  However, at the parents’ death all the insurance money goes into trust — protected from creditors, divorces and lawsuits. It’s a cleaner, neater, more tax-friendly way to create a guaranteed inheritance for the kids.

Peace of Mind

The peace of mind is knowing that whatever happens in the future — inflation, high medical bills, a stock market crash, and if I live a really long time (up to age 120) — I know my kids will at least get the $1 million life insurance policy. The peace of mind is also knowing that now that the kids’ inheritance is planned for, I am free to spend all my retirement money on retirement. I don’t have to skimp on my retirement to leave something for the kids. I can even choose to leave anything that’s left to charity. I can do this because the kids are already provided for because we pre-funded and guaranteed their inheritance with the life insurance policy.

That is the ultimate retirement plan. We spend all our money on our retirement, leave the rest to charity, and the kids get the life insurance policy.

What to consider

  • Life insurance is based on age and health.
  • Premiums and benefits are guaranteed by the insurance company. For this reason, you want to work with a financially sound company.
  • You can pay the insurance premium for a certain number of years or pay for life. Make sure you can comfortably afford the policy, because there are penalties to cancel. I advise finding a premium that fits your budget.

Premiums are the same whether you purchase online or through an agent — there are no discounts. I suggest using an independent agent. For my clients, I shop the coverage around to multiple carriers, talk with the underwriter about each case, and tweak the policy design to make it more affordable for the client.

If you’d like a quote to see if pre-funding an inheritance can work for you, please email me at maloi@sfr1.com.

*For illustrative purposes only, your experience may differ.
**Guaranteed by the claims paying ability of the insurance carrier.

About the Author

Michael Aloi, CFP®

CFP®, Summit Financial, LLC

Michael Aloi is a CERTIFIED FINANCIAL PLANNER™ Practitioner and Accredited Wealth Management Advisor℠ with Summit Financial, LLC.  With 17 years of experience, Michael specializes in working with executives, professionals and retirees. Since he joined Summit Financial, LLC, Michael has built a process that emphasizes the integration of various facets of financial planning. Supported by a team of in-house estate and income tax specialists, Michael offers his clients coordinated solutions to scattered problems.

Investment advisory and financial planning services are offered through Summit Financial, LLC, an SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973-285-3666. This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with their independent tax or legal advisers. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. The Summit financial planning design team admitted attorneys and/or CPAs, who act exclusively in a non-representative capacity with respect to Summit’s clients. Neither they nor Summit provide tax or legal advice to clients.  Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local taxes.

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