Avoiding a Nightmare on RMD Street in a Bear Market ─ How the Payout from a Life Settlement May Ease the Bear’s Bite

As the third quarter of 2022 came to a close, financial experts confirmed the haunting news.

We’re in bear territory.

What’s worse, the combination of a plunging stock market, the unprecedented crash in the bond markets, surging inflation, high interest rates, and the threat of a global recession have created the perfect financial storm for most Americans.

For retired seniors, the outlook seems decidedly grim.

As we enter the fourth quarter and Halloween approaches, millions of retirees are facing their worst nightmare ─ and it’s not on Elm Street.

The values in their retirement investments have plummeted just as the December 31, 2022 deadline approaches for taking required minimum distributions (RMDs) from their tax-qualified accounts.

In order to help guide their clients through the scary days ahead, financial advisors will need every strategic planning tool available, including the liquidity from selling an unwanted life insurance policy.

This article reminds advisors of the problem-solving potential of life settlements in addressing financial challenges, and includes a hypothetical RMD case example to help illustrate the process.

Nightmare on RMD Street

Down market conditions often add a new layer of complexity to managing required distributions. Considering that many retirement accounts plummeted approximately 20% or more by the end of Q3 2022, many retirees may be facing significant RMD stock losses as they take withdrawals before the deadline.

For retirees who have failed to plan properly in terms of their IRA’s asset allocations, the thought of locking in huge losses by selling shares of stock in a down market is beyond frightening.

While most retirees have until December 31, 2022 to make withdrawals, those who turn(ed) 72 in 2022 have until April 3, 2023. But there is a downside to delaying until next year. Those who wait until April will also have to make a minimum withdrawal for 2023 by the year-end deadline ─ meaning they will be taking two required distributions within the same tax year. Financial advisors often caution their clients to be prepared for the fact that the combined taxable income on both withdrawals could push the senior into a higher tax bracket or potentially increase the cost of Medicare premiums.

So unless Congress acts this year to suspend RMDs or raise the trigger age, many retirees age 72 and over face unprecedented RMD challenges that will require extraordinary financial expertise.

RMD Dependent Seniors

Fortunately, some seniors have planned properly with sufficient cash allocations in their IRAs to ride it out until market conditions stabilize. Their highly-skilled financial advisors have deployed all possible planning strategies to help them avoid taking losses.
But the reality is that millions of retirees who may not have planned properly are relying on the cash flow from their IRA withdrawals to meet their spending needs. And while the prospect of suffering heavy market losses from RMDs is daunting, they recognize that the consequence of not doing so is even less palatable.

Depending on the amount a senior is required to take, the opportunity cost of missing an RMD can be significant. If an account owner fails to withdraw the full amount of the RMD by the deadline, the amount not withdrawn is taxed at 50%.
For example, assuming the value of the client's RMD has been calculated at $8,000, the IRS would charge a penalty of $4,000 for missing the required distribution.

Life Settlement Strategy to the Rescue

Let’s assume you have a 75-year old client who proudly has been self-managing his own IRA account by investing mainly in stocks. The client recently developed a major illness and had planned to use the cash flow from his RMDs to pay for ongoing medical treatments.

Based on the value of his IRA and his age, your client’s minimum withdrawal rate was calculated at $12,000 for this year. Faced with substantial stock market losses for taking withdrawals in the down market, the client has asked you to “fix it.”
After conducting a financial planning review and exploring all the options, you discover that the client owns a $1 million term policy that is nearing expiration. Although the client had intended to let the policy go, thinking it had no value to him, you spotted the opportunity for a term-conversion life settlement. The client agrees with your recommendation and you contact Asset Life Settlements to facilitate the process.

Based on Asset Life Settlement’s policy appraisal, the client would likely receive approximately $50,000 for selling the term-converted policy in the secondary market.

You explain to the client that selling his unwanted term policy appears to be the best possible solution to provide the income he needs without taking withdrawals from his IRA. The plan would work as follows:  

  • To meet the required minimum distribution, the client takes the required withdrawals in-kind as stock, meaning the shares of stock are transferred to a regular taxable brokerage account. This strategy helps avoid locking in stock losses by keeping the shares fully invested until the market recovers and the client can benefit from the rebound. Note that the client will still need to address the tax obligation on the income from the RMD.

  • To meet the client’s need for additional income to pay for monthly medical treatments, the $50,000 windfall from selling the term policy is invested in an interest-bearing cash account from which the client makes withdrawals as needed to pay for his medical expenses.
  • In summary, the payout from selling the unwanted policy enables the senior to ride it out for several years until market conditions stabilize and the values in his IRA recover.

  • Take Away

  • As thousands of aging baby boomers reach the RMD trigger age each day, financial professionals have an opportunity to build their practice by offering creative solutions to serve the unique needs of this demographic group. 
    For seniors who qualify, the cash proceeds from selling unwanted life insurance coverage can help address a combination of financial challenges to help the client preserve wealth in a down market.
  • Regardless of the client’s net worth or the amount held in tax-advantaged accounts, the cash windfall from selling a policy can be used for lifestyle expenses in order to avoid taking RMD withdrawals. This enables the financial advisor to deploy other more favorable strategies to meet the client’s RMD obligation, such as transacting in-kind stock transfers, Roth IRA conversions, reinvesting in mutual funds, annuities or via qualified charitable distributions

  • Feel free to contact us at 855-768-9085 to discuss your questions or to request a free policy appraisal.