Tax-Free Retirement Everyone is concerned about saving for retirement and making sure that we survive the golden years. What will our pension be, our 401(k), 403(b), 457, IRA, and even our Roth? In today's economy we wonder what, if any social-security or senior healthcare benefits will exist. To express and answer those concerns, let me go over some highlights from a national best-selling book, Tax Free Retirement, written by Patrick Kelly. Tax-Free Retirement, Page 71: Bill's company has a wonderful 401(k) program... First, the presenter said that the company would match... second... all the income he contributed was tax deferred... third... when he began withdrawing the money in retirement he would be in a lower tax bracket. Since he would be in a lower tax bracket, he would pay less tax. Page 73: Let's take a peek at his future... Bill is now 50... his 401(k) now sits at $848,819... he is almost a millionaire... Bill and Marcy have been scrambling for the last two years to try and pay for Lori's tuition out of pocket...[they] tried looking into financial aid, but with Bill's healthy income they don't qualify. Page 74: He feels like his own money is being held hostage by the tax system. One problem with qualified plans is the non-liquidity until age 59 & ½ without a severe penalty. Another is a large retirement accumulation may hinder student financing for your children. Page 75: Bill is now 65... They are now debt free and ready to take on the new adventure of retirement, grandkids, and leisure... His account now stands at a whopping $3,091,808... Good thing I invested as much as I could in those early years. I guess I did receive good advice. BUT that was before Bill began taking money out of his account. Page 76: Bill's federal tax rate has now risen to 55% overnight. He is stunned. To make matters worse, he no longer has any deductions to offset his retirement income. His kids are grown and his house is paid off. All the deductions that he used when he was younger have now evaporated. Every dollar he takes out of his 401(k) is going to be taxed -- and taxed hard. Wait a minute!, Bill thinks. What happened to lower tax rates in retirement because my income is lower? What happened to the idea of saving the tax during the contribution phase because it is better in the long run?... For the first time it dawns on him that he had never really avoided taxes to begin with; he had simply delayed them. And by delaying them Bill has only compounded them, making them far, far worse than he could have ever imagined. You d be amazed how many retirees just don t spend their lifetime retirement. They re ticked off that they even have to take out the Required Minimum Distribution when they turn 70 ½. Knowing that the government is going to take more than half of every dollar they spend, motivates them to leave the money in their accounts rather than to utilize it for the retirement purpose it was created. They absolutely would rather pass their money on as an inheritance
than give half of it to the government. Little do they know that after they are gone the government will get far more than half before the kids do. Let s continue on with Bill s story. Page 77: It is now five years since Bill's death, But, the biggest shock came when they got the final distribution from their parents 401(k). Of the nearly three million in their father's account, only $476,368, or 15% was passed onto them. Instead of each child receiving close to $1,000,000, after taxes the three children ended up with just over 150,000 each. Patrick Kelly states: Tax-Free Retirement, Page 162: People often think that leaving money in their IRA is a good way to pass on money; but not only is it not a good way to pass on money, it is one of the worst possible ways to pass on money. Page 104: He goes on to say, in fact, The single worst place to have money at death is in a tax-qualified account. So if qualified plans are the worst place to keep your money, then where is the best place? Page 111: Patrick Kelly states, It is my belief that the single best place to save retirement dollars is in a permanent life insurance contract. Patrick Kelly is not alone in his understanding of the benefits of using life insurance to minimize taxes and maximize retirement. Salt Lake Tribune: Bart Croxford, a CPA in Sandy, Utah, states in his article Using Life Insurance to Fund Retirement Has Many Benefits: While tax qualified retirement plans allow an individual to avoid taxes through retirement, heavy taxes are taken out after. A taxfree insurance based plan can maximize your investment over time by allowing taxes to be taken on the "seed" instead of the crop. Mr. Croxford continues, Besides this, the qualified plans have many restrictions and penalties: if you take money out too soon you are penalized; if you are in it too long, you are penalized; if you accumulate too much, you are penalized. Basically the IRS is a terrible partner to have for retirement.
Ed Slott, perhaps the most well-known CPA and premier authority on IRAs, has this to say from, The Retirement Savings Time Bomb, page 154-155: The single best, most costeffective, yet amazingly underutilized strategy for protecting retirement account balances, especially large ones, from being decimated by the highest levels of combined taxation is buying life insurance to offset the tax burden beneficiaries may face. I believe in the concept as the best defense against confiscatory taxation for your family. If the only money available to pay the life insurance premiums is in the IRA, then you should withdraw from the IRA to make those premium payments. Since withdrawals at age 70 ½ are mandatory, why not begin the [dance] early, take out the money that will have to be withdrawn then anyway, pay the income tax on it now, and use the rest to leverage your IRA into a fortune by buying life insurance? You cannot actually buy life insurance with IRA money, tax law prohibits this. When I say, "use the IRA to buy life insurance, I mean you must withdraw first and pay the income tax due on the withdrawal. Then you are free to use the after-tax amount to pay the insurance premiums. If this is your only option, take it -- because the results in the long run will be worthwhile. Ed Slott continues in another book entitled, Parlay Your IRA into a Family Fortune, Page 48-49: While you cannot make a gift of your IRA, you can withdraw funds from it to buy life insurance, which will provide tax-free money to your heirs. It s better financially to tap your IRA and pay the income tax on the withdrawal now, using the net after-tax proceeds to invest in insurance premiums, rather than for Uncle Sam. Every time you pay an insurance premium, you will have removed that money from your estate. If you will be in the top estate tax bracket, which many owners of large IRAs will be, this means the government is paying half of the premiums. This is because had you not purchased the insurance and left the money to grow in your estate, the IRS would have taken almost half of it anyway. For pennies on the dollar, life insurance is the best leverage you can get from your assets. It's also a way for people of modest means to invest a relatively small sum now and provide their family with an estate much larger than they ever had. The fact that life insurance money received in an estate can be totally estate and income tax-free is one of the biggest benefits in our tax code and should be taken advantage of by everyone who owns anything, large estate or small. Bob Kordsiemon (pronounced kords-mon) 2480 Rustic Roads Dr. South Jordan, UT 84095 801-597-2183 bobbykord@gmail.com
Using Life Insurance to Fund Retirement has Many Benefits Tax-Qualified Vs. Tax-Free Retirement Savings Plans Tax-Qualified Retirement Plan Rapid Increase, Rapid Decrease 10 20 30 40 50 60 Time in Years Tax-Free Retirement Plan Gradual Increase, Little Decrease 10 20 30 40 Time in Years While tax-qualified retirement plans allow an individual to avoid taxes through retirement, heavy taxes are taken out after. A "tax-free" insurance based plan can maximize your investment over time by allowing taxes to be taken on the "seed" instead of the crop. Editors note: The "tax -free" life insurance savings plan discussed here requires the investor to put a small seed investment into a large life insurance policy and then take out loans against the policy during retirement to pay for basic needs. The investor can use the interest on loans such as these as a tax deduction, making the loans essentially tax-free. By Bart S. Croxford, CPA Sandy, UT I would like to respond to the article published in the Aug. 28 edition of the Citizens section by Thomas McCarthy, I do not know what financial expertise he possesses but I strongly disagree with his views on retirement. Chances are that he has not "run the numbers" to prove his point. He made assertions but did not back them up with facts and figures. I would like to show with my graphs backed up by a spreadsheet that he is wrong to say that retirement should not be funded with life insurance. I used to share McCarthy's views, but I was convinced that I was wrong when I saw the numbers. In fact, he would be right if it weren't for income, estate and social security taxes. He wrote about inflation and future tax rates. He is right that inflation will eat into a retirement plan, but it eats into a taxqualified plan just as much, or more than it does a tax-free plan. He assumes that a retiree's tax rates will decrease, but if they don't, he will really be in trouble, and I don't think anyone is going to believe that tax rates will truly decrease in our lifetime. Even President Reagan's supposed tax cut in the early 80's didn't last long. In fact, according to recent newspaper articles, he is now accused of authoring a bigger tax increase than President Clinton did a few years ago. McCarthy wrote that the top tax bracket in 1960 encompassed more people than it does today, but l fail to see what the top tax bracket in 1960 has to do with anything. Most retirees won't be in the top tax bracket anyway and we all know how hard the middle class has been hit with taxes for many years. I have never seen anyone who promotes tax-qualified plans run the figures through retirement. They run the figures to age 65 or beyond and show how much more you can accumulate if you use a tax-qualified plan, such as an IRA or 401(k) and defer your taxes until retirement. But in savings as in sports, it's the final score that counts, not the score at half time or even after three quarters. The real clincher in the whole plan is the fact that with tax-qualified plans, one must pay taxes on the entire amount taken at retirement, including the growth, which accounts for the largest portion by far; whereas on tax-free plans, one pays no taxes on the growth at all. In other words, one can be taxed either on the seed or the crop. With tax-qualified plans one pays on the crop, and on tax-fee plans one pays on the seed. One does not receive the tax deduction now but he or she receives a far greater benefit by not having to pay taxes on the amount received at retirement. The benefits are enhanced when one considers that an individual using a tax-free plan will receive more social security benefits because reportable taxable income will be much lower. Also, the user can choose a higher payment pension plan, which ceases at his death (if his employer provides one) because he has life insurance if he dies. Most retirees choose a lower option to allow their spouses to continue receiving pension proceeds after they die. It is also a much more advantageous option for estate planning, because the insurance death benefits pass to heirs tax-free (if properly planned), but the qualified plan will lose 70-90 percent due to income and estate taxes. Even if an employer matches its employee's contributions dollar for dollar, it still doesn't come close to touching a tax-free plan's payout based on investment. In fact, in the graph, I assumed the employer matched the employee's contributions 100 percent. Besides this, qualified plan s have many restrictions and penalties: if you take money out too soon, you are penalized: if you leave it in too long, you are penalized: if you accumulate too much, you are penalized. Basically, the IRS is a terrible partner to have for retirement. The spreadsheet and graphs I have developed prove my point. They compare a qualified plan, such as a 401(k), with a taxfree plan, such as an indexed universal life policy. I have assumed that on the qualified plan, one can cant a 12-percent return annually and a 10-percent return on the tax free plan because about two percent would go to insurance cost and loads. Notice that the accumulation isn't nearly as great on the tax-free plans, but it lasts much longer because one can take loans against the policy tax-free. In fact, one is almost 4 million dollars better off if he she lives to age 95 because instead of depleting the account, it keeps growing, even though the net amount enjoyed by the retiree is exactly the same ($108,560) in both cases. I used to feel the same way Mr. McCarthy does, but when I looked at the whole picture, including initial taxes and taxes through the withdrawal period, it made much more sense to me to use life insurance to fund retirement.
Ed Slott is a highly sought-after professional speaker, CPA, and tax advisor. He has appeared on the nationally aired public television special Stay Rich Forever & Ever with Ed Slott. His diverse client list includes major corporations such as Fidelity, LPL Financial, ING, New York Life, John Hancock, and Nationwide Insurance. Slott frequently appears in such national publications as The Wall Street Journal, The New York Times, USA Today, and on broadcast television and radio stations across the country. Ed Slott is the best source of IRA advice. -- The Wall Street Journal Ed Slott is one of the leading authorities on the complexity of retirement plans and Roth IRAs. He has true expertise in this area. -- Chicago Sun-Times Ed Slott s easy-to-understand tax strategies mean money in your bank account, not the IRS s. -- The New York Times It would be tough to find anybody who knows more about IRAs than Ed Slott. -- USA Today