Ultrawealthy clients may be better off claiming Social Security early and using the benefit checks to fund life insurance, creating a potentially estate-tax efficient asset for heirs.
Individuals with estates exceeding $15 million and married couples with estates above $30 million could be subject to federal estate taxes. Such clients are often advised to delay claiming Social Security to take advantage of benefit increases and because they don't need the monthly income, said Ash Ahluwalia, managing director and head of Social Security planning at Red Bank, New Jersey-based OneTeam Financial, which offers retirement planning and wealth management services.
However, he advises some clients with potential estate tax exposure to claim Social Security before full retirement age and buy life insurance with the checks. Doing so can create an income-tax-free death benefit and, if properly structured, an asset outside the taxable estate. Life insurance proceeds can also be passed to heirs, whereas Social Security benefits generally end when the beneficiary dies.
The life insurance policy would be owned by an
Ahluwalia said the strategy runs counter to what he described as common advice from CPAs and financial planners that healthy, wealthy retirees should wait to take Social Security as long as possible.
"What I'm doing is swapping a potential Social Security income stream into a guaranteed income and estate-tax-free asset in the form of life insurance that can help pay their estate tax," Ahluwalia said in an interview.
"As long as the Social Security recipient is insurable for life insurance, or if it's a couple, at least one of them is insurable, we can use the Social Security benefits now to create this tax-free asset," he said.
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Using Social Security to fund legacy planning
A similar strategy could be useful even for those who are not expected to owe estate taxes. Ahluwalia said he is using this strategy to help a 63-year-old client leave life insurance proceeds to a grandchild.
The usefulness of this strategy would depend on the amount of the client's life insurance premiums, which can vary significantly based on health and other underwriting factors, said Robert Conzo, the CEO and co-founder of The Wealth Alliance, a registered investment advisory firm based in Melville, New York. One 67-year-old might pay $1,000 a month in premiums, while another of the same age could pay $5,000, he said.
"So the real answer to financial planning questions, and you hate to say this because it sounds like a cop-out, is: It depends," Conzo said.
Advisors should look at clients' individual goals to assess whether Social Security strategies such as this one involving life insurance make sense.
"It's all a question of what your goals are," said Jay Pelham, president of Miami-based registered investment advisor Kaufman Rossin Wealth. "If you're trying to create as large a pool of assets to your heirs as possible, life insurance is a way to do that, regardless of whether you're accepting your Social Security or not, and we use life insurance from an estate planning standpoint quite frequently."
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The strategy is generally most applicable to clients who are no longer working, retirement consultant Heather Schreiber noted. Claiming benefits before full retirement age while still earning income can reduce benefits under
If a person is "not working, then this definitely could be a strategy that would work because what happens is, when your estate is that high over the limit … and they're still having to pay estate taxes, by establishing an irrevocable life insurance trust using Social Security income to fund it," it is outside the estate, and "that could be used to pay the estate taxes that are due," said Schreiber, founder and president of HLS Retirement Consulting in Atlanta. "For certain people, that absolutely would be something to think about."
