(Presentations in this blog were created using the InsMark Illustration System)
My good friend, Wayne Weaver, a principal with First Financial Resources, uses a wonderful phrase when referring to retirement planning, “Tax the seed, not the harvest”. Wayne is making the distinction between 1) deducting contributions in exchange for taxable retirement cash flow versus 2) using after tax dollars to fund either indexed universal life (“Indexed UL”) or indexed survivor universal life (“Indexed SUL”) in order to obtain tax free retirement cash flow using participating loans.
We’ll examine Wayne’s logic in this Blog using one of the most dynamic of qualified plans, a Solo 401(k), a strategy used by self-employed and owner-only companies. The conclusions you can draw are applicable to any form of deductible 401(k), 403(b), IRA, Keogh, Section 457, or profit sharing plan.
Contribution Limits for a Solo 401(k)
An eligible employee can stash away as much as $18,000. The company can contribute an additional 25% of compensation up to a maximum of $54,000, including the employee contribution and $6,000 more if age 50 or older. The amount can double if a spouse is also employed (think of doctors). These contributions are discretionary, so the maximum can be saved in flush years and nothing in tougher times.
Below is a summary of the Solo 401(k) plan limits for 2017:
Case Study (both doctors are in the same practice)
David Bennett, MD: Vascular Surgeon, age 50
Lily Bennett, MD: Anesthesiologist, age 50
Retirement age: 70
Marginal Tax Bracket: 40%
Plan: Max Solo 401(k) for each assumed yield: 7.00%
Max contribution: $60,000 each ($54,000 plus $6,000 catch-up for a total of $120,000)
Annual after tax cost of both Solo 401(k)s: $72,000
Alternative funding: Indexed SUL at 7.00% Premium: $72,000
Note: In the illustrations that follow, I have combined both David and Lily’s numbers into one Solo 401(k) and one Indexed SUL. If you use the logic of this Blog, you should probably do individual plans for each of them (due to likely personal preferences).
Below is the comparison showing a significant advantage to the Indexed SUL where the participating policy loans starting at age 70 produce annual after tax cash flow of $248,296. If the Solo 401(k) matches that after tax cash flow, its values are depleted by age 86.
|Indexed Survivor Universal Life|
Click here to review the comparative year-by-year numbers and associated graphics from the Other Investments vs. Your Policy module in the InsMark Illustration System.
In addition to the difference in retirement cash flow, the Indexed SUL has several other advantages:
- Unlike the 401(k), the Indexed SUL provides a significant life insurance death benefit for Robert and Lily’s family.
- Unlike the 401(k), a waiver of premium can be attached to the Indexed SUL in the event of disability.
- Unlike the 401(k), tax free cash flow from the Indexed SUL can be accessed prior to age 59 1/2 with no 10% premature distribution tax.
- At the conclusion of the illustration, the Indexed SUL contains $1,141,336 of residual cash value and death benefit; the Solo 401(k) has $0 residual value.
- If it turns out that a significant income tax hike will be required in the future to deal with the federal deficit, the 401(k) will be seriously impacted, and the Indexed SUL will be unaffected. Below is an example of what the comparison looks like if a 70% income tax bracket were to occur at the Bennetts’ retirement in ten years (not a farfetched assumption). It’s not a pretty picture.
|Indexed Survivor Universal Life|
|Retirement Income Tax Bracket Increases to 70%|
Click here to review this variation.
“Compared to What” remains a benchmark of any sound financial analysis. And always remember Wayne Weaver’s advice: “Tax the seed, not the harvest.”
Cash value life insurance is an exceptional alternative to a deductible 401(k), 403(b), IRA, Keogh, Section 457, or profit sharing plan. InsMark can really help you convey this to your clients and prospects.
The only exception to this point involves plans where an employer is making a matching contribution such as a 401(k). In that instance, the employee should continue with a contribution large enough to max out the employer’s match and direct an amount equal to the after cost of the difference to an indexed life insurance policy. Blog #61: Sacrificing Cash Flow with a 401(k) Plan discusses this approach in detail.
|Another approach is to ask this question of a client who is maxing out a contribution to a deductible 401(k), 403(b), IRA, Keogh, Section 457, or profit sharing plan:|
|“If you could contribute more to your deductible plan, would you?”|
You will be surprised at the answers you get. For those that indicate they would contribute more, ask “how much?” To see how to present this concept, read Blog #68: A Pretend 401(k) Plan vs. Indexed Universal Life.
InsMark’s Digital Workbook Files
If you would like some help creating customized versions of the presentations in this Blog for your clients, watch the video below on how to download and use InsMark’s Digital Workbook Files.
Note: If you are viewing this on a cell phone or tablet, the downloaded Workbook file won’t launch in your InsMark System. Please forward the Workbook where you can launch it on your PC where your InsMark System(s) are installed.
If you obtain the digital workbook for Blog #153, Click here for a guide to its content.
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Important Note #1: The hypothetical life insurance illustration associated with this Blog assumes the nonguaranteed values shown continue in all years. This is not likely, and actual results may be more or less favorable. Actual illustrations are not valid unless accompanied by a basic illustration from the issuing life insurance company.
Important Note #2: Many of you are rightly concerned about the potential tax bomb in life insurance that can accidentally be triggered by a careless policyowner. Click here to read Blog #51: Avoiding the Tax Bomb in Life Insurance.
Important Note #3: The information in this Blog is for educational purposes only. In all cases, the approval of a client’s legal and tax advisers must be secured regarding the implementation or modification of any planning technique as well as the applicability and consequences of new cases, rulings, or legislation upon existing or impending plans.