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.
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