Email Article Print Article

IRA Rescue

By Roccy M. DeFrancesco, JD, CWPP™, CAPP™ - Email Editor

Date : May 13, 2008

In the past two weeks, we have been discussing the subject of the double tax trap of money in a qualified plan or IRA.

Our first goal is not to have an estate tax dilemma upon your death. Your first task was to take a look at the funding of your IRA and your 401(k) plans and to make sure it makes sense to continue to fund them (which for many it will not, as doing so will create or further create the double tax dilemma).

This is part one of a two part newsletter explaining the proper role “home equity management” can play when trying to posture your estate for maximum wealth and minimal taxes.

Building Wealth Through Cash Value Life Insurance (it’s not a cure all).

The reason financial planners and insurance advisors counsel clients to build wealth with cash value life insurance is fairly simple. 1) Cash in a life insurance policy grows tax-free and can be removed tax free in retirement (via policy loans). 2) When a client dies, the death benefit will pay income tax free. Money in IRAs, annuities and 401(k)/Defined benefit plans will, for many readers, be hit with both income and estate taxes at a client’s death.

I discuss the potential of building wealth through the use of the “right” cash value life insurance policy in conjunction with the concept of Equity Harvesting in my book The Home Equity Management Guidebook - Paperback Version. Equity Harvesting is a fancy term for removing equity from a home to fund cash value life insurance in an attempt to build the most tax-favorable wealth for retirement.

Equity Harvesting can be a terrific tool (even “the best tool”) to build a safe tax-favorable retirement nest egg for many readers. The kicker is that in order to use cash value life insurance as a wealth-building tool for “retirement income,” you really need to be UNDER the age of 65 and under the age of 60 would be better.

Why? Because if you wait the cost of insurance will be too high and you will not have as many years to allow the money to grow tax-favorably in the policy. This will significantly diminish the amount of tax-free retirement income you can remove from the policy.

There are books out there that you can read that will tell you building wealth through equity harvesting works for “everyone.” That is not true and to read the problems with these books you can go to www-missedfortune101.com or www-stopsittingonyourassets.com.

The following will examine the problems with using Equity Harvesting and cash value life insurance to build a retirement nest egg.

The following example will illustrate the difference in building wealth through the stock market, annuities, and cash value life insurance.

For the following examples, we’ll use Dr. Smith, age 60 who has a home worth $500,000 (with NO debt) that we will assume he will sell. He plans on buying a new condo in the sunshine state and retiring. We will assume he decided to use $420,000 of the proceeds from the sale in order to create a larger retirement nest egg to be used when he turns 70 years old.

Also assume Dr. Smith has a $5,000,000 estate (total) of which income producing bonds makes up $1,000,0000 and an IRA makes up $1,000,000 of the estate.

LIFE INSURANCE

If Dr. Smith purchased an equity-indexed life insurance policy on his life, where he was considered “standard” health for underwriting purposes, and repositioned $420,000 from the sale of his house into that policy, he could remove income-tax free from the life policy $35,000 a year from ages 70-84 (I assumed a 7.5% rate of return in the indexed life policy).

EQUITY-INDEXD ANNUITIES (EIAs) (ALSO KNOWN AS FIXED INDEXED ANNUITIES (FIAs)

What if Dr. Smith repositioned the $420,000 into equity- index annuities (EIAs)? If the annuities returned a reasonable 5.5% annually, then he would be able to withdraw after tax $51,314 in the 40% income tax bracket, $55,422 in the 30% bracket, and $61,585 if he was in the 15% bracket.

All of the after-tax withdrawals from of the annuity beat the tax-free income from the life insurance policy.

STOCK MARKET

What if Dr. Smith repositioned the $420,000 into the stock market earning the same 7.5% assumed rate of return? If we assume a 20% blended capital gain/dividend tax rate annually on the growth and a 1% mutual fund expense (no money management fee however), Dr. Smith could remove $62,773 after taxes from the brokerage account every year for the same 15-year period (ages 70-84).

Dr. Smith can remove more from the stock portfolio, however, in the stock market, there is NO protection if the stock market tanks. With the EIA, Dr. Smith has principal protection (and maybe even a guaranteed payout, depending on the product).

From an estate tax point of view the stock portfolio is inside his estate and will be hit with estate taxes at his death, the EIA is an IRD asset and can be hit with both income and estate taxes at his death (income taxes on growth in the EIA), and with the life insurance policy, a death benefit will pay income tax free but not estate tax free to the heirs.

With the above example, Equity Harvesting to build wealth at the age of 60 does very little to help mitigate Dr. Smith’s estate tax problem and nothing to help eliminate the double tax of money Dr. Smith has in his IRA.

SUMMARY

My point with part one of this discussion is that Equity Harvesting for retirement income is difficult to make work for someone who is at or over the age of 60 years old and I want to caution readers not to fall prey to this sales pitch.

Secondarily, I’m setting up next week’s newsletter where I will show you how Dr. Smith can use the proceeds from the sale of his home to significantly increase the size of his non-taxable estate so he can pass the maximum amount of wealth to his heirs while at the same time mitigating the double tax that awaits the money in his IRA

If you would like to be in step with this topic please go the the side link and purchase the The Home Equity Management Guidebook - Paperback Version.

RELATED ARTICLES:

• Protect the equity in your home
• Asset Protection Plans
• C.A.L.M. Introduction
• Get educated on Asset Protection