Case Study

Sue and Billy Anderson

Retired Couple

Sue and Billy worked their entire lives for the local utility company – 39 years for Sue and 42 years for Billy. The company paid into a pension at the beginning then offered a 401(k) plan later which they both took advantage of. When they retired at 65, their combined 401(k) balance was $750,000. They receive combined social security benefits of $2,500/month and combined pension benefits of $2,000/month. They told me they didn’t need their 401(k) but that they didn’t want to lose it either. I can’t say that I blame them. They worked and saved all their lives for that nest egg. I’d want to protect it too!

We discussed the Indexed Annuity and how the money can still grow tax-deferred without the risk of the stock market. They liked that idea and signed paperwork to rollover their 401(k) into an IRA Indexed Annuity. I explained that the money could continue to grow but eventually they would have to take Required Minimum Distributions.

The money did grow. In fact, by the time Sue and Billy turned 72 their IRAs were worth $1,250,000. We had to begin required minimum distributions. The first distribution was calculated at $50,000. Here’s the problem. Currently they were paying less than $500 in state and federal income tax on their combined income of $54,000. You may be wondering how that’s even possible. The short answer is that your Social Security Benefits are not taxable unless you have additional income that exceeds the amount allowable by the IRS and, the current standard deduction for married couples filing joint is $25,100. So, for all intents and purposes, Sue and Billy were flying below the income tax radar. But that was all about to change. Remember, distributions from an IRA are taxed as ordinary income. As you might imagine, adding another $50,000 of taxable income would significantly increase their tax liability and it did to the tune of $12,500! Here’s the kicker. They don’t want or need this income but the IRS will only allow you to defer the tax on tax-deferred accounts to age 72 so they have no choice but to withdrawal the funds and pay tax.

I asked Sue and Billy to come into the office because I had an idea I wanted to discuss with them. I knew they had been members and supports of their local church for years so I presented them with the following recommendation. Take the required minimum distribution of $50,000 and donate it to the church. By doing so, the income would be offset by the charitable contribution and no income tax would be due. Yes, they would be taking money out of their IRA, tax-free. They liked the idea! But I took it a step further. I gave them another option that would involve paying the $12,500 in tax and using the remaining $37,500 to purchase a life insurance policy where they make their church the beneficiary. They both smiled and said what would that look like? I said, “about $850,000”!

I could tell the wheels inside their heads were turning so I told them that when I ran the numbers, I only used 10 premiums meaning they were only committing to make this payment from their IRA for 10 years. So, whatever remained in the account after the 10 years would pass to their 3 children equally; approximately $250,000 each. Remember, this was the value of the account when they retired. They smiled really big and Sue said, “you mean we can leave the church  850,000 and still have $250,000 for each of the kids?! Yes. Yes, you can.

It’s worth mentioning here that we wrote this insurance policy on Sue because women are cheaper to insure which means we could purchase more death benefit for the same amount of money. Unfortunately, Sue and Billy were in a car accident and passed away two years after we wrote the policy. What’s interesting is that the church received the $850,000 death benefit but Sue and Billy only  had to make 2 payments totaling $100,000. This left a balance in their IRA of around $1,150,000 to split equally between their 3 children.