Use RMDs to pay for life insurance.

How It Works:

1. Take RMDs from Your IRA

• Once you reach age 73 (previously 72), the IRS requires you to take RMDs from your traditional IRA or other tax-deferred accounts like 401(k)s. These distributions are taxable as ordinary income.
• You cannot directly use funds inside an IRA to purchase life insurance, but you can take your RMD, pay the income taxes, and then use the after-tax amount to purchase a life insurance policy.

2. Convert Taxable RMDs into Tax-Free Benefits

• Life insurance policies, especially permanent ones (like whole life or universal life), can provide tax-free death benefits to your heirs.
• Using your RMDs to pay for life insurance premiums, you turn taxable IRA withdrawals into tax-free inheritance for your beneficiaries.

3. Offset Estate Taxes

• For high-net-worth individuals, IRA distributions might lead to estate tax liabilities. By purchasing life insurance with RMDs, you can create liquidity to cover potential estate taxes, ensuring that your heirs don’t have to sell assets to pay taxes.

4. Roth IRA Conversion

• Another option is to convert your traditional IRA to a Roth IRA (though you will owe taxes on the conversion). This allows you to avoid RMDs on the Roth IRA. Then, instead of dealing with mandatory RMDs, you can use other funds (or planned distributions from investments) to purchase life insurance.

Benefits of This Strategy:

• Tax-Free Death Benefit: Life insurance payouts are generally tax-free, allowing your heirs to receive the full benefit.
• Estate Equalization: If you have multiple heirs, life insurance can provide equal value to each, especially if other assets are difficult to divide.
• Avoid RMD Impact: Converting taxable RMDs into life insurance mitigates the tax impact of annual distributions while securing a legacy for your heirs.
• Provide Liquidity for Estate Taxes: The life insurance payout can cover estate taxes, ensuring that your heirs aren’t forced to sell off valuable assets like real estate or investments.

Risks and Considerations:

• Premium Payments: Premiums can be high depending on the size of the life insurance policy and your age, so ensure that the RMDs are sufficient to cover them.
• Health Underwriting: Life insurance approval is contingent on your health, and it might not be available for older individuals or those with certain health conditions.
• Estate Planning and Tax Rules: Consult with tax advisors and estate planners to ensure this strategy aligns with your financial goals.

Conclusion:

While you can't directly purchase life insurance with IRA funds, using RMDs to pay for life insurance premiums can be a powerful way to protect and transfer wealth to your heirs tax-efficiently. This strategy works particularly well for those facing taxable RMDs and wanting to convert those distributions into a tax-free benefit for their beneficiaries.