You’ve worked hard for decades and saved diligently. You’re a Baby Boomer just a few years from retirement and feel you’ve planned well for it.
But like many nearing the finish line of their working life, you’re concerned about two things in particular — taxes and long-term care — and how those factors could affect your projected retirement lifestyle. Dealing with both may require adjusting parts of your plan.
Taxes are front of mind, given that the Tax Cuts and Jobs Act of 2017 (TCJA) will soon sunset and significantly impact required minimum distributions (RMDs). The legislation that lowered tax rates in all brackets ends on December 31, 2025. Regarding long-term care, people are living longer, but relatively few Americans have purchased LTC insurance, with the high cost being the most common reason.
The good news is there are solutions that can help mitigate the tax and long-term care concerns. And one that could potentially do both.
Converting to a Roth IRA — the counterpunch to the RMD
RMDs are the minimum amounts you must withdraw from your retirement accounts each year. The SECURE 2.0 Act increased the RMD age from 72 to 73, effective January 1, 2023. The starting age for RMDs will jump to 75, effective January 1, 2033.
Doing a Roth conversion of one’s retirement accounts is a popular recommendation because it can help to eliminate the blow of RMDs. Converting to a Roth IRA before the TCJA sunsets makes sense because you’ll pay taxes on the conversions now, while tax rates are lower, instead of paying taxes on traditional IRA withdrawals later, when the rates are possibly even higher.
While converting a traditional IRA to a Roth IRA means paying ordinary income taxes on your contributions in the year of the conversion, the long-term benefits could be worth it.
The key reasons to convert a traditional IRA into a Roth IRA are:
- You can withdraw money from a Roth IRA in retirement without paying taxes or penalties on the withdrawal, as long as you’ve met the five-year holding requirement.
- There are no RMDs with a Roth IRA, as there are with a traditional IRA, which has yet to be taxed until you withdraw funds from it. The point of a Roth is that it’s already taxed money that grows tax-free, and the interest grows tax-free also.
Converting a traditional IRA into life insurance — an answer for LTC
The older we get, the more expensive our health care is. And it’s estimated that 7 out of 10 Americans will eventually need long-term care. It's a massive issue for Baby Boomers heading into retirement without a plan for LTC, but a solution for it is tied to the Roth IRA — essentially making an investment in order to pay for LTC.
While the Roth conversion into an individually owned Roth IRA can be a good tool, it might be worth your while to consider a Roth conversion alternative (RCA). It will perform similarly to a Roth IRA in terms of tax benefits, but it may also give you the ability to obtain LTC protection. What RCA means in this context is converting your traditional IRA into a permanent life insurance policy, such as an indexed universal life (IUL) cash value policy or a whole life policy, both with chronic/terminal illness riders. With either approach, not only can you get the benefits of the conversion by 1) paying the tax on it now, before the TCJA sunset, and 2) not paying taxes on withdrawals (and no RMDs), but you can 3) get the added benefits of owning insurance, creating tax-free income or growth and having improved long-term care protection.
Many IUL and whole life policies have chronic-illness riders to help pay for long-term care costs. An IUL has good growth potential, as the policy tracks a market index, which you are able to participate in, up to a percentage or cap. Permanent life insurance policies from participating companies may generate dividends that can be quite helpful later in life since the cash value accumulated can be assessed to help pay for unexpected emergencies, retirement and college education funding.
You’ll be able to withdraw up to the amount of the total premiums you’ve paid into the policy without paying taxes. If you take out a loan from your life insurance, the loan won’t be taxable, the exception being if the policy terminates before you’ve repaid the loan. And through a death benefit left to your loved ones, you can leave a legacy tax-free. There are no RMDs for those who inherit it. The one caveat is that you will need to be insurable to purchase the policies.
A sound strategy?
Is an IRA-to-IUL conversion strategy sound? For many, the answer is yes, but with important qualifications. Like many financial strategies, IRA-to-IUL conversions can be beneficial for some while not being appropriate for others. Additionally, as with any insurance strategy, proper structuring of the policy is crucial to help ensure your goals and objectives for purchasing the policy can be met.
Everyone needs a plan for long-term care expenses in retirement. And no one wants to pay higher taxes in retirement. A Roth conversion alternative might be an avenue for you to handle both issues and enjoy your ride into the sunset.
Dan Dunkin contributed to this article.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
This document is designed to provide general information on the subjects covered. It is not, however, intended to provide specific legal or tax advice and cannot be used to avoid tax penalties or to promote, market or recommend any tax plan or arrangement. Individuals are encouraged to consult with a qualified professional before making any decisions about their personal situation. Life insurance agents do not give legal or tax advice. Our firm is not affiliated with the U.S. government or any governmental agency. Life insurance products contain fees, such as mortality and expense charges, and may contain restrictions, such as surrender charges. If properly structured, proceeds from life insurance are generally income tax-free. This document is not designed to be a comprehensive discussion of the financial products mentioned. Product and feature availability may vary by state. Guarantees and protections provided by insurance products are backed by the financial strength and claims-paying ability of the issuing insurer. This document is not intended to serve as the basis for any financial or purchasing decisions. None of the information contained herein shall constitute an offer to sell or solicit any financial product. Insurance products are offered through the insurance business Swan Financial Group, Inc. Swan Financial Group, Inc. is also an investment advisory practice that offers products and services through AE Wealth Management, LLC (AEWM), a registered investment adviser. AEWM does not offer insurance products. The insurance products offered by Swan Financial Group, Inc. are not subject to investment adviser requirements. AEWM and Swan Financial Group, Inc. are not affiliated companies. 02425023-6/24
