Q. I have assumed power of attorney for an elderly friend who is 88. Due to scams and/or financial mismanagement, her finances are sketchy. Social Security covers most of her living expenses, and she has two life insurance or annuity contracts – one is “qualified” and the other is “non-qualified.” I also found a letter from another company asking if she wants to take her RMD from an IRA. She apparently owes $7,000 in federal income tax from cashing out some kind of account. How can I help her best?
A. We’re sorry hear about your friend’s financial situation.
Let’s start with your statement about one of the policies being qualified and the other being non-qualified.
The “qualified” policy signifies some sort of retirement account, said Betty Thomas, a financial planner with Lassus Wherley in New Providence.
At 88 years of age, your friend should be taking Required Minimum Distributions (RMDs) from this account, Thomas said.
Then there’s the non-qualified account, which was purchased with after-tax money.
“If she is not currently taking funds from this account, when she does, a portion of each payment would be considered a return of her original investment and would be excluded from gross income,” Thomas said. “The difference would be considered earnings and taxed at her ordinary income tax rate.”
The death benefit and cash value may differ. Assuming your friend is the person insured on these policies, the death benefit is the amount payable to any beneficiaries once she passes away, Thomas said, while the cash value balance is a savings component of the policy available to her while she is still living.
If life insurance and annuities are the only available account types to access cash, withdrawals from either may have future tax ramifications, she said.
Thomas recommends you contact the IRS to begin an installment payment agreement on taxes currently owed.
“This should give you time to contact her other financial institution and add the power of attorney to accounts, giving you the ability to get a better understanding of what she has,” she said. “This would be a short-term solution, with the end goal of paying off the installment agreement as soon you have a better idea of where the money should be withdrawn.”
If she has older life insurance policies that pay annual dividends, this might be another option to consider for available funds, Thomas said.
The dividends received on older policies were used to either purchase additional life insurance or increase the cash value, and they’re usually non-taxable, she said. The IRS considers them a return of premium rather than a traditional dividend.
“If there are dividends paid, and were used to increase cash value, contact the insurance company to discuss withdrawing them and ask if there would be any tax implications,” she said. “These dollars could be used towards the payment of the current federal taxes due without increasing her future tax liability.”
Another option, which Thomas calls a “last resort,” is a loan against her whole life insurance policy.
“Because the money is already within the policy and available, it would be a quick source of immediate funds to pay the current tax bill,” she said.
Once you have had time to sort through the other accounts and have determined where it would make sense to move money from, immediately repay the loan, Thomas said.
“Interest rates on policy loans vary, and the cash value amount available to be borrowed may be limited,” she said. “Life insurance policy loans do not have to be repaid, but it is recommended that if you do consider a policy loan as an option, at the very least make interest payments so that the policy loan amount does not increase.”
Also, borrowing against an insurance policy will reduce the death benefit to the beneficiaries should your friend die before repaying this type of loan, she said.
Thomas said you could benefit from sitting with a professional to sort this out.
“There may be other issues that need to be addressed financially but also with you, a friend, having power of attorney over her affairs,” she said. “It is admirable that you want to protect her, but make sure you are protecting yourself as well.”
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