Jan 18, 2019 3 min read

Some people are fortunate to have enough financial resources to leave a legacy to family members or a special cause. If they have accumulated more than they need to consume in their lifetimes, they could multiply the size of their gift with proper planning.

Today we are going to discuss tax-efficient ways to leave extra qualified money to family members. Qualified money consists of IRAs, 401(k)s, deferred comp and other such tax structures. When you contributed to these accounts, you got to reduce your income by the amount of the deduction and this savings was allowed to grow tax-deferred.

When you withdraw money, you must pay ordinary income tax on these funds. They also are subject to required minimum distributions at age 70½. Not taking these RMDs will result in a 50 percent penalty of what you should have taken, plus taxes on the entire amount. This could amount up to 80 percent of the distribution going to the Internal Revenue Service.

Some people believe they don’t need to spend these RMDs, so they wonder what to do with them. If you want to leave a bigger tax-free legacy, you may want to buy life insurance with the money. The death benefit from life insurance is income tax-free to the beneficiary. There are many different uses for life insurance, so it is important to purchase the correct product. All policies are not created equally. This can leave a nice tax-free benefit.

If done properly, you may be able to stretch the balance of your qualified money to other family members upon your death. They will be required to start RMDs on this stretch, even if they are not 70½. But because of their younger age, the required minimum distributions could be much lower. This money could continue to grow at a faster rate tax-deferred. This means that, potentially, the amount left to beneficiaries might grow to three or four times the starting IRA value.

While you can do either of two strategies independent of each other, it can be beneficial to combine them. If you have grandchildren, you may want to designate your children as beneficiaries of the life insurance and stretch the IRA to the grandchildren. This is because they would be younger and benefit more from the continued tax deferral.

If you do not have grandchildren, you could employ both strategies with your children. Because they would receive the big tax-free life insurance benefit, it would be easier for them to not take more than the minimum required amount out of the stretch.

Many people have too much stock market exposure at this time. These strategies might provide a good rate of return and lessen some of this risk. There could be coverage available even for people with less-than-perfect health. Both of these strategies utilize the tax code to provide more benefit for your family.

Remember, it not just how much you earn that is important, but how much you get to keep.

Gary Boatman is a Monessen-based certified financial planner and author of “Your Financial Compass: Safe passage through the turbulent waters of taxes, income planning and market volatility.”

To submit columns on financial planning or investing, email Rick Shrum at rshrum@observer-reporter.com.