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Life Insurance: An Array of Uses

With Federal and State income taxes rising, more retirees are concerned that their children will not be able to fully retire. In California, it’s not uncommon to see taxpayers paying over 50 percent of their earned income to taxes.

Wealthy parents are looking for ways to help fund their children (or even grandchildren’s) retirement shortfall. One of the best new plans on the market is an indexed universal life policy (IUL). The concept is fairly simple. Fund a life insurance policy on your child with level payments over a set number of years (usually 5-10 years). We want to have the smallest amount of death protection possible to still qualify as life insurance.

The cash values grow quickly since the costs are minimal due to the low death benefit. They can be invested in an account that tracks the S&P 500 index from year to year. The funds receive 100 percent of the upside of the index during the year (subject to caps of 12-14 percent) but none of the downside risk. In the event of a negative year, the policy is simply credited with zero interest and resets for the next year. For a risk-free investment, the short and long term returns are very favorable.

At some point in the future the monies can be withdrawn income tax free to help supplement retirement. The policy allows a withdrawal of your premiums paid without producing taxable income. After these monies have been withdrawn, the policy owner can continue to take out money by borrowing against the policy. The loan is a “wash loan” meaning no net interest costs. This allows for a completely income tax free distribution while still enjoying a life insurance death benefit. Upon death, whatever death benefit is left in the policy will be paid to the beneficiaries income tax free (and possibly estate tax free also).

I recently worked with someone where we set up a plan to fund $50,000 per year for 10 years for their 42 year son. His initial life insurance coverage is $2.4 million. The plan is to have him start distributions at age 65. We project about $100,000 per year will be distributed to him starting at age 65 through age 90 based on past returns. Of course, if the fund does not produce the projected results then less will be taken out and a higher return will increase the overall retirement payout.

If $100,000 were paid out tax free to him that is the equivalent of earning $200,000 per year before tax based on his current income tax burden.

One strategy is for Mom and Dad (Generation 1 or G1) to fund a plan for their children (generation 2 or G2) by utilizing annual gifts. This gets monies out of their estate and reduces possible estate taxes later. We have also seen G1 decide to keep the monies in their estate in case they need the money themselves later on. They would be the owners of the policy on G2 but turn it over to them at some point in the future or at G1’s demise. Of course, this also works well for Grandchildren (G3) utilizing the same concept except with a longer deferral period.

Lastly, many age 40-60 year old boomers hoping to retire someday do not have parents able to fund such programs so they have to fund their own policies. Often nicknamed a Super Roth, unlimited amounts of money can go into these IUL plans helping to provide income tax free payments in their retirement years.

With the current estate tax exemption of $5.34 million per person, I am finding more people worried about rising income tax rates and its effect on retirement assets than about avoiding estate tax. With indexed universal life, both income and estate tax planning can be accomplished across multiple generations.

It is always best to consult your professional advisors to assist with advice on how best to set up your plan.

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2760 Sycamore Canyon Road
Montecito, CA 93108

Phone: 805-969-2367
Toll-Free: 800-950-8522

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4501 Tamiami Trail North, Ste. 419
Bank America Center
Naples, FL 34103

Phone: 239-649-7600
Toll-Free: 800-950-8522