• Can You Legally Cut The Taxman Out Of Your Retirement?

    by  • May 31, 2013 • Retirement Planning • 6 Comments

    7966931958_1529e7df6fIt’s been said the only certainties in life are death and taxes, to which Will Rogers famously quipped, ” Death doesn’t get worse every time Congress meets.”

    Do you think tax rates will be higher or lower in the future?  By placing your money in accounts with differing tax treatment, you may be able to greatly reduce or even eliminate your tax burden in retirement.

    Here are some retirement plans you may be familiar with or more specifically the tax codes they are associated with:

    401(a) = 401k (Defined contribution plan)

    403(b) = Tax advantaged plan for public education (teachers)

    408  = IRA (Individual Retirement Accounts)

    408(a) = Roth IRA

    So what are Retirement Plans?  Simply put, retirement plans are tax codes that dictate the parameters on how money is treated tax wise when you contribute to a plan, when your money grows within a plan, and when you withdraw funds from a plan.   Retirement plans are not investments.  What you choose to do with you money once inside the retirement plan is the investment.

    It is incredible what a small number of investors know about the best IRS-approved retirement savings plan. It is not a 401(K), Roth, annuity or whole life.   It’s a specially designed Equity Indexed Universal Life contract.  If the contract meets the requirements under Title 26 US Tax Code 7702, earnings are tax deferred and withdrawals can be considered tax-free.

    Before we delve into explaining why Equity Indexed Universal Life is a powerful retirement savings and distribution tool, we must acknowledge that after a generation of use of defined contribution plans, i.e. 401(K) plans, they are considered by many experts as a failure. We have become so accustomed to think that the 401(k) retirement account is the best option but is that because it is often our only option.

    The solution: a new type of insurance. Retirement savings, it turns out, are exactly the type of asset we need insurance for. We need insurance to protect against risks we can’t predict (when the market collapses) and can’t afford to recover from on our own.

    Before we discuss the basic principles of Equity Indexed Universal Life it’s important to note that they have enjoyed a 14-year track record.  You insure virtually every valuable aspect of your life – health, home, vehicle so why not protect your safe, comfortable retirement against the risks we can’t predict and can’t afford to recover from on our own, and why not cut out the tax man in the process?

    These are all legal, and totally above board, established life insurance principles. It may sound too good to be true, but it’s just what life insurance is and does. Yet the general public—and even many financial advisors—have absolutely no idea that a tax-free, market-risk-free, gains-locked-in, congressionally-approved solution has been sitting right under their noses for 14 years. Equity Indexed Life’s primary benefit is the fact that, like an indexed annuity (and unlike a mutual fund Roth), you keep the gains and suffer none of the market losses. But there are many more benefits included that other investment can’t lawfully offer.
    What exactly is Equity Indexed Universal Life?  Let’s lay out the basic principles of Equity Indexed Universal Life, and then go through a rough example to demonstrate just how powerful a retirement and Tax savings tool this vehicle is.

    Equity Indexed Universal Life’s basic principles:

    1. Generally funded with after-tax monies but can be pre-tax monies, as in a defined-benefit pension plan.

    2. Assets are protected against market loss and backed by the full faith and credit of the issuing company. While the funds are not FDIC-insured, “legal reserve” requirements apply with the insurers.

    3. Assets are “linked” to the market via the selected index: Dow, S&P 500, Global, or a mix of several indices.

    4. Any gains, being real, interest-bearing gains (subject to a cap), are locked in and never given back: the policy holder accrues a gain, or a zero (in the case of a down market), but never a market-induced loss.

    5. Historical returns, based on actual illustrations from the top carriers going back to the late 1980s, are usually somewhere between 7-9%, mean actual interest rates of return.

    6. Income can be pulled out prior to age 59.5 and is “tax-free.” A withdrawal is considered a policy loan against the death benefit, which acts as collateral.

    7.  The death benefit is paid out to the beneficiary tax-free.

     

    You can use EIUL both as an alternative to contributing to your IRA/401k over a 20-30 year period, or you can use it as tax efficient strategy to get the money OUT of your IRA/401k after you have already contributed 20-30 years.

    Let’s look at an actual case study of a client that has contributed to his IRA/401k his entire life and show you the power of using the tax code in your favor.  Now, this is just an illustration, and if there is one thing to consider about an illustration, it’s that its accuracy can’t be guaranteed, as it’s a hypothetical estimate.

     

    For our example, let’s use a hypothetical client. Jim, age 59 1/2, is unmarried and has one son age 24.

    Jim has about 90% of his assets in qualified 401k and IRA accounts.  Jim expects to retire and start collecting Social Security at age 66.   What if Jim were to reposition some of the IRA assets now into an EIUL over the next three years.  Let’s forget for a moment the potential RISK he is taking in his IRA because his assets are non-principal-protected from market loss.

    How would that compare to just leaving the funds in the IRA?

    Jim moves $84,000 a year out of his IRA into an IUL for the next 3 years for a total of $252,000.  He uses a tax free policy loan to pay the roughly $25,000 in additional income tax each year so the EUIL is funding itself. This example assumes Jim never pays back the policy loan.

    After the three years of contributing to the EIUL,  Jim reduces the death benefit by the maximum amount allowed under IRS code 7702. (This important step maximizes accumulation and minimizes death benefit but keeps the distributions tax free.  This step blows away the argument that UL is too expensive as the client gets older because we have reduced the amount of death benefit to just slightly above accumulation value)

    Let’s assume both the IRA and the EIUL compound at 7.7% for the next 11 years.   (Keep in mind the market would only need to compound at 5.5% since the participation rate in the EIUL is set at 140%)

    At age 70 the EUIL would allow $35,000 a year TAX FREE income to the age of 100 = $1,085,000, plus a tax free family benefit of $630,299.  That is 31 years of TAX FREE income and a TAX FREE family benefit.  TOTAL BENEFITS = $1,715,299

    If you continued the current traditional IRA and spread the income for the same 31 years, it would only generate $26,288 after tax each year.  That would equal $814,932 of net income and a difference of $270,068 of lost income and ZERO tax free family benefit.  Total Difference $900,367

    Let’s look at this another way and say you continued the traditional IRA but withdrew $35,000 after tax per year to match the EIUL,  You would drain you IRA assets by age 85 having collected only $567,533 and leaving zero family benefit.  Total Difference $1,147,766

    This example does not consider the IRA income could cause taxation of you Social Security benefits under the current Tax law.  The EIUL would have no impact on the Social Security calculation.

    While past performance is never any guarantee of the future, we really cannot illustrate these products historically at less than 7-9% interest rate returns, since you make a gain or you get a zero and participate 140%.

    On top of this, these returns are all passive; you didn’t have to manage anything. Additionally, since there is no age 59 1/2 IRS restriction, many parents can use EIUL cash values for college funding.

    Equity Indexed Universal Life may offer you much greater benefit over conventional investments depending on the actual index returns and your tax bracket. This is a result of protection of principal against market losses, the indexing, and legally cutting out the tax man.  Please consult a competent financial advisor and tax professional before making any decisions regarding your specific situation.

     

    Photo credit: Flickr

     

    About

    Tim Mobley is a Louisiana licensed professional who has over twenty years of experience serving the community. He is passionate about working with clients and his goal is to educate and inform them so they feel confident in the decisions that will shape their future. Whether you are concerned about getting out of debt, outliving your retirement, paying too much tax on Social Security benefits, or keeping your money safe in a changing global economy, Tim is a trusted source. His business and personal focus is to coordinate your investment objectives from a tax planning perspective.

    http://www.barongroup.net

    6 Responses to Can You Legally Cut The Taxman Out Of Your Retirement?

    1. Pingback: Carnival of Wealth, Chick-Fil-A Is Now Within 150 Miles Of Us Edition | Control Your Cash: Making Money Make Sense

    2. July 23, 2013 at 1:06 pm

      Equity Index Universal Life (EIUL), just like any other Universal Life policy (or any life insurance that builds a cash value) is a rip off.

      They are over priced; money withdrawn is really a LOAN; they don’t build much savings; and the COST OF INSURANCE (not the premium outlay, or what the client pays) increases every year for the life of the policy, thus cannibalizing the client’s cash value to pay for premiums until the client has no savings left.

      If someone is 59 and a half years old, wants to retire and is scared of risk and losing money in the market, and wants tax benefits, get an annuity as an IRA/Roth IRA.

      Forget this 7702 EIUL garbage. It’s just another scheme the life insurance industry has come up with to charge expensive premiums, take cash values from clients, and get off the hook from paying death benefits.

      Nice try, but you haven’t fooled me. An EIUL is one of the dumbest things you can do financially.

      • July 31, 2013 at 3:13 pm

        Overpriced is a point of view. Allow me to explain. Contrary to popular belief every financial product has a cost to it, every one of them!! You said that the fees are high and the income is really a loan in the life insurance and that if someone wants to retire that an IRA/Roth IRA inside of an annuity is the way to go.

        First off there are really 2 discussions occurring here. The 1st is regarding tax codes and the 2nd is regarding fees and belief in a financial instrument.

        Let’s start with Taxes.

        IRA-pretax contributions, fully taxable distribution.

        IRA’s code section 408: Is a trust designed in the United States to be used for the benefit of the owner of said trust. Many were told that if they put money away in an IRA that they will save money on taxes and have a large sum of money accumulated and be in a lower tax bracket when they retire. What is the reality of these plans? The reality is that taxes are higher. Most will pay back their entire tax savings over 3-4 year period then pay it back every 3-4 years for the rest of their life. It gets better! Then when they pass on the money goes to the spouse, then the kids, then the grand kids and they pay the tax savings back over their lifetimes multiple times. In essence An IRA is not a retirement plan that has the owner of the plan in mind. Uncle Sam has essentially lent the owner a tax savings during their working years then created a 3 generational tax erosion plan for the government and placed itself as one of the primary beneficiaries of the account. So this is just touching on the tax code not even the investment, YET!

        Roth IRA-After tax contribution, tax free distribution

        408(a) is a subsection of the code surrounding IRA’s. While I like the features of a Roth IRA as it pertains to tax free distribution there is still the issue of funding the plan. There are limitations as to how much one can contribute to a Roth every year. If you are in the pre to current retirement years starting one of these plans with max contributions is not a great solution to retirement. There are also parameters set up that allow an individual to convert their IRA to a Roth IRA. This involves the individual paying the taxes on the IRA however substantial they may be. There are also income limitations to whether or not you will be allowed to do so. These limitations were exempt in 2010 (only in 2010) under the TIPRA 2010 provision. As I am sure you are aware it is 2013, therefore this provision does not come into play anymore. If the Roth Ira has just been formed then there is a 5 year waiting period before the individual can access interest in the plan (you can access the principal which doesn’t say much for longevity of your money). One note on Roth IRA’s: These are great if you are planning for your heirs. Even if you only minimally fund one of these plans. Let’s say you set up your grandkids as the beneficiaries of these plans for example. When you pass away you have met the requirements (over 59.5 or death) for your any age grandkids to have a completely tax free trust from which to invest with for the rest of their lives! Thanks Grandma & Grandpa!

        Life Insurance

        7702 (primarily) dictates that the benefit is tax free. Define benefit: Death Benefit or Loans from the policy. Yes taking loans from a policy is not income, you are correct! What nasty thing comes with income? Taxes! A very simple question to ask yourself is: “Would I prefer Tax Free money at Retirement or Taxable”? Fairly simple question with I am sure a very simple response. Also, life insurance, specifically Index Life Insurance, has a mechanism built in that if utilized correctly will allow the client/owner/insured to move money to the tax free plan without all of the tax ramifications being put on the clients accounts.

        Ok, so we have talked about the tax side of this remark and can see that tax wise an IRA is not an effective way to control taxes. We can see that a Roth IRA, while containing essential components to tax freedom has issues as it applies to funding. The life insurance has the proper tax coding to create tax free monies for retirement but also allows a mechanism inside to move large sums of money to it from various taxable sources without the full tax burden.

        Fee’s..

        Everything has fees! When you invest you are investing with a company or in a company. The company you invest your money with you want to be profitable but, not so profitable that you are losing money right. The average fee on the life of a PROPERLY DESIGNED IUL is 1-1.5%. Now the interesting point was made that everyone who is retiring should be in an annuity. While I do agree that Annuities are for the Senior populous and that there are benefit s to annuities, I completely disagree that they are a one size fits all product and even more so that there are no fees!

        Fees come in many ways. Either up front with IUL or hidden and/or upfront with a fixed annuity. The hidden fees are the low earning potential of the caps, and the upfront fees are for any riders added to Fixed Indexed Annuities. ( Lets not even get into FEEs on variable annuity contracts). The bottom line is that any company product you decide to invest in is going to have the company’s bottom line for expenses covered. You just need to decide that based on your specific situation, does this product offer more benefit than other products I am considering? …and don’t forget taxes, That is a HUGE part of the equation.

        I would be happy to offer you a free review and compare how all of the products mentioned would compare in your specific situation!

        Regards,

        Tim Mobley

    3. Al
      August 18, 2013 at 3:18 am

      This is an interesting discussion. There is an associated risk with EIUL. EIUL is somewhat related to life insurance that an investment scheme. It all depends in the purpose of investment. Each avenue has its advantages and disadvantages.

      • August 19, 2013 at 2:52 pm

        You are absolutely right! There is never “one size fits all” solution.

    4. November 20, 2013 at 8:43 am

      Because it is a 101 course(beginners) article, I will not get into any
      thorough detail about certain subjects. Money you give rise to this plan will count as income
      on your tax return but can be withdrawn and received tax-free whenever you retire.
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      of if you decide to set up your own gold IRA.
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