Leveraging Your Qualified and Non-Qualified Plan Annuities for Tax Free Distributions

Let’s start with the qualified plan money first. Most people are taught by their tax advisor to put off taxation until retirement, whereby you will be in a lower tax bracket, because your income is lower. While that may be true, let’s analyze that a bit.

In today’s economy, government spending has gone through the roof. In fact, if we look at the national debt, even if all taxes doubled across the board, it would still take over 30 years just to cover the interest cost of the new debt. With that in mind, do you really think your tax rate will go down ? Maybe your income, but certainly not your tax rate. 

So how can we gain some leverage on this taxation ? 

Retirement plans are typically rolled over to an IRA when we retire. That may not be the best place for it. If you have achieved your goals during your working years, you have accumulated some assets, and probably more than what is in the walls of your home. Many people in this circumstance have some form of self employment going on, or are at least generating a schedule a or c on their tax return. If you can justify any of this, then you can qualify as self employed. 

Self employment allows us to do things we couldn’t do before. Things such as setting up our own 401k plan. Again, we speak of the Solo 401k. The difference between a regular 401k and a Solo 401k, is that in the Solo we have no employees to cover, just ourselves. If that is the case, then plan administration and tax reporting of the plan changes dramatically. If you have less than $250,000 in your plan, you do not even need to file a tax return for the plan (5500 form filing). This gives us a lesser burden to manage, and with a 401k plan we have the ability to purchase life insurance inside the plan.

Now, you may ask why we are pushing life insurance inside the retirement plan ? There is great advantage in doing this. We anticipate two different scenarios:

1) Assume you plan to spend most of the retirement plan assets, and you still want to leave money behind for your children. I minimum funded life insurance product can be quite affordable, especially inside the retirement plan. By doing this, and paying the economic benefit annually (term cost applied to your tax return), you can buy a lot of savings and inheritance for your kids. The term cost is reported via a 1099 to your tax return, and all contributions to the policy go back to the plan at your death. Any funds in excess of the cost are paid to your named beneficiary. Let’s assume that you have paid in $50,000 to the policy over your lifetime, and the death benefit is $1,000,000. This means that at death the retirement plan gets the $50,000 back from the policy and is distributed after tax to your heirs. But the other $950,000 goes directly to your heirs without a dime of income tax. Quite the leveraging technique.

2) Assume you have more than enough income and assets outside the retirement plan,and you do not want to spend the money, other than the required minimum distributions by law. Here we would want to make the insurance policy look and act like a performing investment. By using the maximum amount of cash contributions, and the lowest amount of death benefit, we gain a performance advantage. The average rate of return on investment can exceed 8%, which is usually better than the Wall Street Casino will treat you. Again, like the above example, the principal returns to the retirement plan to be taxed and all earnings go to the named beneficiaries circumvent of income tax.

While you can justify other examples of insurance design, this is simply to get you an idea of how this can apply for you. A qualified financial planner can help you sort through this quite easily. 

Now let’s take a look at Non-Qualified plans, such as your tax deferred annuities that are not part of your retirement plan. These plans can come from annuities, or cash savings from bank accounts such as certificates of deposit, and even market based fixed accounts. All of these have a few commonalities. They are either too risky, or non performing. A performing asset must at least pace inflation, of which bank accounts do not. Let’s start out with a way to replace a bank CD with a performing insurance product. 

Bank products, first and foremost do not provide any tax benefits. At the end of the year, the bank sends you a tax statement in the form of a 1099 to enforce taxation of the account. Not only do you not get a rate of return, but the rate that you do get is reduced by taxation. If you are in a fixed account for a security, you get the same tax treatment, but a better rate of return. Still the downside exists that you do not even pace inflation.

If we look at the history of the insurance industry, prior to June of 1988, insurance products offered investments that outpaced banks, and offered tax free returns on top of that. While those rules no longer apply, a modification can be a great alternative.

Single Premium Indexed Life can be a good fit here. By taking the invested cash and buying a single premium into either an indexed “Whole” or “Universal” life product can provide a vehicle that can outperform the banks. Some of these products offer a choice of fixed or variable rates, and even the fixed rates sometimes achieve or exceed 5% (at the time of this writing). The investments are tax deferred, and if you don’t spend them, the death proceeds are tax free. For many that are in the banks, just wanting safety and liquidity, but not intending to use the money, this is a marvelous alternative.

What if your advisor tells you to take your money and buy an annuity. This can be a Fixed annuity, of Fixed Indexed Annuity, or even a Variable Annuity. All of these are very popular in today’s world. The fixed and fixed indexed annuities offer differing investment choices, but due to constraints of the insurance industry, they are forced into lower rates of return. If you chose the variable rate annuity, you have applied a much higher risk. 

The insurance industry has long sought out solutions that attract buyers, and this situation is no different. The trend at present is to place some guaranteed amount of growth for the purpose of income on the product. This means that if your growth rate is say 5%, each year the plan grows by 5% in the accumulation side. What happens when we want to take our money out ? Now you have a function of overall performance to watch out for. If your account has been at the same company for many years, and the market has a downward trend, your income will remain based upon the higher amount, but your liquid value is way down. This can be a problem, either in the case of a cash emergency, or at the time you die, as your account will revert to the lower guaranteed amount. Additionally, regardless if your annuity has performed well or not, the end result at death is taxation. Isn’t that the old adage, the only thing certain in life is death and taxes. That applies here too.

A wonderful solution to managing your money for life, and taxation is again a properly structured life insurance product. By using the indexed life plan, and making a maximum deposit with a minimum death benefit, we can have a policy that looks and acts just like an annuity, only with substantially higher returns. The indexed annuities have maximum earning power based upon a short term option platform, whereby the life products are based upon a long term platform. The result is higher caps on earnings, and far more flexibility. If you want to change the income stream to create tax free income, you simply have to change the funding process to a longer period, to conform with current tax laws.

In any of these case designs, two things remain common. The first is a higher rate of return, and the second is what happens at death. All life insurance products pay an income tax free death benefit, which outpaces any investment in this category many fold. If you are choosing your product for income, or even emergency income, by choosing the variable rate loans on these plans, you have the capacity for leveraged income, and the numbers sometimes can be staggering.

Contact us today at (800) 341-5433 or via this contact form to learn more about the opportunities associated with this strategy.