By Boyce F. Lowery, CLU, ChFC
Diversification. It’s one of the first things we learn about when seeking to save for the future. We’ve heard this saying all of our adult lives: Don’t put all your eggs in one basket. It seems like one of the few things that most financial professionals actually agree on. But what does diversification really mean?
Types of Diversification
If you’re like most people, you would probably say that diversification means holding a mix of equities, fixed income instruments, and other traditional assets in your portfolio. It’s spreading your money around so it’s not invested too heavily in one place.
While diversification is a commonly accepted method of managing risk and return, did you know that diversification can be used to manage taxes as well? Diversifying from a tax perspective gives you the potential for higher net income during your hard-earned retirement years. Who doesn’t want more money?
In fact, by using life insurance as a nontraditional retirement asset, you can provide for yourself a source of funds that is not tied to other volatile assets. This can be vital for those who choose to stay heavily invested in the markets as they approach retirement or for those who have already entered their retirement years. When you reach this time of your life and your accumulated assets are still largely exposed to the markets, a significant downturn could be disastrous for your finances, despite your best attempts at traditional diversification.
Tax Considerations for Retirement Assets
Diversification for tax management isn’t so much about the financial vehicles you choose, but rather the kinds of accounts that they are held in. It is important to understand how asset growth is taxed in different types of accounts so that you can manage your accumulated assets strategically. Some accounts are taxed annually, some are taxed at a later date, and some are never taxed at all.
Some of the accounts where asset growth is taxed annually include money market accounts, CDs, and savings accounts. On the other hand, traditional IRAs, 401(k)s, and 403(b)s are taxed when money is withdrawn from those accounts. Among the financial assets that might never be taxed are Roth IRAs and cash value life insurance.
How Could Life Insurance Fit Into Your Retirement Plan?
A properly designed Life Insurance policy can add strategically important tax diversification to your retirement planning. Further, the internal rates of return on cash accumulation and income of a properly structured life policy can far surpass other “safe” assets without the same inherent risks associated with those other traditional safe assets. It is critical to note that the amount of tax one pays on Social Security retirement benefits and the premiums that will be charged for Medicare are based on one’s TAXABLE income. Tax-free income could potentially save you a significant amount when tax is calculated on your Social Security benefits. Your taxable income will also affect how much you will be required to pay for Medicare during your retirement years. The more tax free income you have, the less likely you will be in the higher tax brackets during your retirement years.
A Look at the Numbers
Let’s look at an example. Bob is in a combined 25% total tax bracket when his retirement begins and he withdraws $100,000 annually from his 401(k) to live on. At his current tax rate, he pays $25,000 in taxes and has $75,000 left for spendable income.
Joe, however, got a little more creative. He used some of his money in his pre-retirement years to accumulate funds inside a cash-maximized life insurance policy. At retirement, he needs the same amount of money as Bob and is in the same tax bracket.
He takes half of the money he needs from his 401(k) and half from the life insurance policy. The 401(k) withdrawal generates a $12,500 tax bill, but he owes nothing on the life insurance policy cash flow. Therefore, he owes half of what Bob does in taxes. By combining the life insurance cash proceeds with his 401(k), Joe increased his net income by $12,500 a year. Further, if his 401(k) account takes a big hit from a market downturn, he might choose not to touch the 401(k) with the hope that the account will eventually recover. Making withdrawals from an account which is already reduced from a sizable market downturn further exacerbates the problem, with the very possible result of running out of money in retirement.
Contrary to traditional belief, life insurance isn’t just about death benefits. Nowadays, many people turn to life insurance for supplemental retirement income and long-term wealth accumulation in addition to the traditional death benefit.
How I Can Help
Could a cash-maximized life insurance policy be a wise addition to your retirement assets?
The only way to know if one of these policies is right for you is to sit down with an experienced independent financial professional who understands the nuances of these types of insurance policies and knows how to maximize the benefits for you.
It would be my honor to have a more thorough conversation with you about this topic. Feel free to call me at 888-827-0146 and we can discuss this or any other creative uses for life insurance.
Boyce Lowery is a 40-year veteran and established expert in the insurance industry. As the owner of Suncrest Advisors, he aims to provide financial security and peace of mind to business owners, executives and professionals, and high net worth individuals across the United States. Along with more than four decades of experience, he is a Chartered Life Underwriter® (the premier designation for insurance professionals signifying specialized knowledge in life insurance and estate planning) and a Chartered Financial Consultant® (known as the advanced financial planning designation). To learn more, visit http://suncrestadvisors.com/ or connect with Boyce on LinkedIn.