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(Presentations in this blog were created using the InsMark® Illustration System)
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A Solo 401(k) is one of the most dynamic of qualified plans. It is a strategy used by self-employed and owner-only companies where, in 2019, up to $62,000 in combined plan contributions can be deducted for those age 50 and over. Under age 50, the limit is $56,000.
Blog #186 introduces you to an insurance-funded alternative using Indexed Universal Life (IUL) and compares it to a Solo 401(k).
Case Study
Mark and Jennifer Thompson are owners of Thompson Oral Surgery, PC. They are the only employees of the firm.
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Client Details:
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Solo 401(k) Funding:
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IUL Funding:
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Click here to view Mark’s IUL illustration.
Click here to view Jennifer’s Illustration.
Click here to view a composite of both illustrations.
Note: This composite is not valid unless accompanied by basic illustrations for each insured from the issuing life insurance company.
Below is the comparison showing a significant advantage of the IUL policies in which participating loans start at age 70 for both Mark and Jennifer. Those loans produce a combined annual after-tax cash flow of $280,000. When the combined Solo 401(k)s match that after-tax cash flow, both expire at age 83.
| Image 1 |
| Solo 401(k)s vs. IULs |
s-vs-IULs-769x496.jpg)
It is difficult for some consumers to accept that such differences can realistically occur in favor of IUL. Here’s why they do:
- Cash values securing IUL loans participate in the selected index;
- Retirement cash flow via IUL loans is free of income tax;
- IUL death benefits are free of income tax including any cash value component whether policy loans exist or not;
- Overall plan costs (fees, taxes, mortality charges) are much lower with IUL compared to a Solo 401(k).
Below is a graphic from Page 6 of the illustration reports featuring the difference in overall plan costs between the Solo 401(k)s and the IULs.
| Image 2 |
| Solo 401(k)s vs. IULs |
| (Comparison of Plan Costs) |
s-vs-IULs-(Comparison-of-Plan-Costs)-769x760.jpg)
| * | The Comparison graphic above compares management fees (1.00%) and income taxes (40%) on retirement withdrawals from the Solo 401(k)s to the mortality charges and policy expenses associated with IULs. (There is no income tax on loans from an IUL.) |
Click here to view the full illustration with contributions, premiums, and benefits. On Pages 4 and 5, you can see the year-by-year costs associated with each plan.
Video Analysis of the Comparison of Plan Costs
Click here for an 11-minute video refresher for the specifics of the InsMark Comparison of Plan Costs including details of the data input procedure. (It is the same for all three comparison modules in the InsMark Illustration System.)
In addition to the difference in retirement cash flow and residual values, IUL provides several other advantages:
- Unlike a Solo 401(k), IUL provides a significant life insurance death benefit.
- Unlike a Solo 401(k), a waiver of premium is available for IUL in the event of disability.
- Unlike a Solo 401(k), tax-free cash flow from IUL policies is accessible before age 59 1/2 with no 10% premature distribution tax.
- If a significant increase in federal income taxes is required in the future to deal with a spiraling federal deficit, it will have a severe impact on cash flow from a Solo 401(k); IUL will be unaffected.
InsMark’s Digital Workbook Files
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Files For This Blog
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Watch the video.
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If you obtain the digital workbook for Blog #186, click here for a guide to its content. It will be invaluable to you.
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Important Note #1: The hypothetical values associated with this Blog assume the nonguaranteed values shown continue in all years. This is not likely, and actual results may be more or less favorable. Life insurance illustrations are not valid unless accompanied by a basic illustration from the issuing life insurance company.
Important Note #2: 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.
Important Note #3: Many of you are rightly concerned about the potential tax bomb in life insurance that can accidentally be triggered by a careless policyowner when policy loans are present and net cash values are so low that the income tax on the gain on surrender (calculated using gross cash values less basis) is more – often significantly more – than the net cash surrender value.
This lurking tax bomb can be present in all forms of whole life and universal life where policy loans of any type are utilized. It can be avoided, and you, the producer, are key to making sure your clients are aware of how to sidestep it.
A tax bomb can be avoided if the policy is neither surrendered nor allowed to lapse, since the policy death benefit wipes away the income tax liability. The foundation of this special treatment is IRC Section 101. This statute provides that the proceeds of life insurance maturing as a death claim are exempt from federal income tax. This applies to the full death benefit, including any cash value component whether loans exist or not.
Can your clients remember these facts years into the future? If they are incapacitated, will family members understand the issues? It is probably best to file a short note with the policy – something like this (although your compliance officer will likely have preferred language):
If/when you take policy loans on this policy, be sure to talk to your financial adviser before surrendering or lapsing the policy in order to anticipate unexpected tax consequences that may otherwise be avoided.
Some life insurance companies have concierge units that monitor loan status at the point of lapse or surrender, and you would be well-advised to select an insurance company with this capacity. To be effective regarding the tax bomb, such carriers need to be proactive in their client relationships, not merely reactive to client inquiries. I hope that ultimately the policyholder service division of all life insurance companies will bring this potential liability to the attention of those surrendering or lapsing policies, particularly those policies with 50% or more of the gross cash value subject to outstanding loans.