Forever Taxed or Never Taxed – If You Have Taxable Savings, You Have a Problem; by Established CPA and tax adviser, Ed Slott

Forever Taxed or Never Taxed – What does your retirement plan include?

If you have taxable savings – you have a problem, and so do your beneficiaries!

Forever Taxed or Never Taxed - Ed Slott

Life insurance may be the most under used strategy to protect large retirement balances from being decimated at the highest levels of taxation. Who is most at risk? Those of you who have the largest IRA’s or other tax deferred savings accounts.

Most people don’t understand how life insurance works as an effective planning tool. Life insurance can fix lots of retirement problems and even create wealth; and tax free wealth.

Understand what life insurance tax planning can do for you both during your lifetime and after your death.

Ed wants you to understand what’s in it for you from an unbiased, objective, tax advantaged point of view. Let Ed tell you why he thinks life insurance is the missing piece in most peoples retirement and estate plans.

The tax exemption for life insurance is the single biggest benefit in the tax code.

Good News

Taxes are money problems but can be avoided with great planning. Life insurance puts lots of tax free money in your pocket.

Bad News

1/ Problems that affect you during your life time

2/ Problems that affect your beneficiaries, your family after your death.

If you have taxable savings, you have a problem, and so do your beneficiaries.

Silent retirement killers:

1/ TAX RISK  –  especially taxable accounts like IRA’s and 401k’s an even bigger risk than investing in stock market is tax risk. Most people believe that having the savings they have in these retirement accounts is enough. It is not. It is what you get to keep after taxes that is important. There is a mortgage on your tax deferred retirement savings that is owed right back to the government. In fact taxes could be 50 or 60% by the time you reach in for yours.

That’s not real money. The only real money is tax free money. Spendable money where you keep it all.

Plus with IRA’s and 401k’s you have to take required minimum distributions on that money after you reach 70 1/2 years old and you are forced to pay taxes on the governments schedule. 5:51 Not yours. That’s the government plan. That’s not real money since it is all subject to tax. 5:57

Are you wondering what future taxes could do to your future retirement security? You should be. You know why? Because you have caused the problem. Especially if you have done everything right. You saved, you sacrificed, you built a healthy retirement account in a 401 k and an IRA, so what’s the problem with IRA’s? The problem is they are tax deferred, not tax free. 6:20 That money will be taxed at some future point. With an IRA, a SEP IRA, a simple IRA, 401k, 403b or any other type of tax deferred retirement plan you received your tax deduction up front. Your retirement funds have grown tax deferred all these years. So far so good. You’ve done well. But there will be a day of reckoning. You will owe income tax when you begin to withdraw. Just when you need the money the most. How much tax? We don’t know. That’s the problem. You won’t know that until you need the money the most. This uncertainty keeps people up at night.

2/ MARKET RISK – Your retirement savings and other investments invested in the stock market are also at risk of being lost. Wall street fraud and manipulation or a market crash at the wrong time for you.

Review –7:17  Typical tax deferred savings accounts are subject to two major risks: Investment risk and tax risk. Now here’s where the life insurance comes in. Life insurance can be used to remove both of these risks. 7:34 Investment risk with life insurance you get certainty, a guarantee. You cannot get a guarantee in the stock market. And Tax Risk is eliminated because you never have to pay tax on this money. So you need to create a plan to move your money from accounts that are forever taxed to accounts that are never taxed. Life insurance is the best provision in the tax code to do that. 7:59 Wouldn’t you sleep better at night if you knew your retirement savings were no longer subject to these risks.

So what are the benefits and how could you use them in your planning?

First when I talk about life insurance I am referring to Permanent Life Insurance. Even with permanent life insurance there are several options so you need to speak with an insurance professional for all of those details. 8:27 For those looking for retirement security and estate protection.

You leave a problem for your family if they inherit mostly taxable funds. They will be dealing with these tax issues too. They also may be dealing with estate taxes depending on the tax law when you die, and that changes all the time. So you need to plan for the worst case scenario and hope for the best. 9:15

Your family will also most likely have a liquidity problem if retirement funds and other assets have to be cashed in quickly in order to raise money after death for taxes and other post death expenses. Money is often needed after death to resolve all kinds of issues besides taxes. I am talking about families that squabble etc. family members wanting money more quickly. The last thing you want is for your family to have a fire sale especially if there is a family business or valuable property in your estate. 9:47 You don’t want your family wasting or cashing out retirement accounts or selling valuable property because cash was needed quickly.

 You need to do a liquidity test right now and see if your family will have a cash problem after death? What does Ed’s liquidity analysis do? It shows you how much of your estate can be turned into cash quickly without triggering taxes or losing property value. 10:20

Cash is often needed after death even if there are no estate taxes. That’s only federal taxes, don’t forget state estate taxes. There are lots of expenses and the IRA is the last account you would want to tap into to pay those bills. Remember IRA’s are subject to both income taxes and estate taxes which could eat up a lot of cash quickly.

 Liquidity Test 11:02

1/Make a list of all the assets you own,

2/less liability, mortgages, debts etc. in other words your net worth.

3/Now you have all this property. Now code it as either liquid or non-liquid. (By liquid I mean those assets that can most easily and quickly be turned into cash without triggering a tax. What I call money you have to pay on a toll on to get it – toll money Here is what I mean, IRA’s I would not include as liquid assets. You might say I have all this money in my IRA, but you have to pay a toll to get it. It is not liquid. You have to trigger taxes to get it. So I wouldn’t put IRA in with liquid assets or cash.)

 To find out how liquid you are we do a calculation. A fraction.

The numerator is the liquid assets. (Cash, bank accounts, money you can get easily and quickly get at without triggering a tax bill or any other expenses or losing significant value like a fire sale. Sure you could get money out of it quickly if you sell for a low price.)

The denominator is the value of your entire estate. 12:30 (This includes everything included in your entire estate. Cash, IRA’s, 401k’s, business interests, real estate,, include all property in addition to the IRA’s. Now look at that percentage, look at that fraction. For most people cash over the entire estate is about 5% if even that much. Do you know what that means? turn it around and that most estates are 95% illiquid. Unless you actually do have a ton of cash laying around available, but most people don’t.

Most people, when I do this liquidity analysis, at that moment, realize that they have a huge liquidity problem.

So now you know you have tax exposure, stock market risk, AND a liquidity problem.

So how can life insurance help?

Two ways. during your lifetime so there is something in it for you right now and after your death. 13:24

During your lifetime you have the ability to stop stock market risk and tax risk by moving your money from accounts that are forever taxed to accounts that are never taxed. There are two ways to do that, Roth IRA’s and Life Insurance. Both cost money now but with life insurance you’ll be creating a bigger pot of tax free money later. when it is most needed. It would be great if you could do both and turn your estate into a tax free windfall both during your life and after death. But the more powerful way is with life insurance. And again I am talking about Permanent Life Insurance that has cash value.

You can contribute more generally to a life insurance than you can to a Roth. With a Roth IRA it is easier to access your money if you need it. (Blog owner comment – I do not agree with this statement but Ed is not a life insurance agent so maybe does not understand IBC)  Roth IRA’s are income tax free too. A Roth IRA is tax free too but they are a part of your estate and are subject to estate taxes. But Roth IRA’s provide no additional death benefit as life insurance does. Life insurance comes with a guaranteed death benefit, and that benefit unlike a Roth IRA can be set up to estate tax free too.

So what can you do to remove both the stock market risk and the tax risk? 14:35

1/ You can leverage your retirement savings like an IRA. If you have a large IRA it might pay to draw it down now and pay tax on the distributions then use those distributions to invest in a Permanent Life Insurance policy. Remember tax rates are at an all-time low right now so now would be the best time to strike. Even if it costs you some tax money it still pays because you are lowering your tax exposure on your IRA. And anyway, after age 70 1/2 mandatory withdrawals from the IRA must begin whether you like it or not. Since the money will eventually have to be withdrawn anyway it may as well be leveraged by using the money to pay the life insurance premium. You’re basically paying off the mortgage on your IRA early so you never have to worry about tax risk. And the funds invested in your permanent life insurance policy are now growing tax and risk free. And you can have lifetime access to the cash value, tax free, if you need it at retirement. So during your lifetime, in effect, you can turn your taxable IRA 15:46 and other taxable savings into a tax free savings vehicle. It’s really just like changing pockets from taxable accounts to tax free accounts 15:54 except now you have also built in a guaranteed death benefit to benefit your family. It is generally judgement proof too.

Many people are looking for places to shelter money from taxes, stock market risk and law suits are stuffing taxable money into permanent life insurance as a lifetime personal protected savings account. All the growth is tax free for life and beyond. So those are the benefits to you over your lifetime.

What about post death benefits for your family?

 If you don’t need to tap into your funds during your lifetime, your beneficiaries are guaranteed a death benefit. The stock market has no such guarantee. Your family will have access to guaranteed tax free cash. Tax free means they keep every cent. No tax erosion here. They will have tax free cash to pay estate taxes if needed to pay expenses, debts, mortgages all without triggering taxes or having to sell a family business or other valuable real estate or other property that could trigger taxes. If you had to use your IRA to pay these bills they would first have to pay income taxes and may be estate taxes too leaving very little for bills or for them.

So don’t just sit there and admire your IRA like most people do, leverage it now. Use it, leverage it, or lose it to possible higher future taxes. 17:33  Never underestimate the value of leveraging IRA money by using it to pay life insurance premiums. The larger the estate the higher the estate tax. Having enough insurance money available to cover the estimated estate tax will avoid having to invade the IRA to pay the tax.

Some people might say but the current estate exemption now is so much higher so there probably won’t be estate tax. You know what, this has been changing on and off over the years this is not an option you can plan with. The estate plan exemption has been changing up and down and you cannot take that kind of risk. 18:10

 Anyway what’s the down side? Your beneficiaries will simply inherit more money, and it will all be tax free. That’s the down side.

OK so let’s continue with that scenario and say there is no estate tax, there are still plenty of uses for life insurance even if there is no estate tax. You can use life insurance to replace stock market losses. I had a doctor client a few years ago that had this account – about 3 million bucks in a brokerage account. He said I want that to go my family. I want the 3 million to go to my kids. But then the stock market crash hit and he lost a million dollars in the market, so now his value is only two million. What did he do? he went out and immediately got a million dollars of life insurance. He replaced all that lost value immediately. Now he still has the three million to leave his kids. 2 million that’s left in the portfolio plus a million of life insurance. He replaced losses immediately. 19:14

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Life insurance can also be used to provide tax-free money for beneficiaries so that they do not have to withdraw amounts in excess of their required minimum distributions on inherited IRA’s. Here is what I mean, you might want to set up a stretch IRA for them where they take only the minimum amounts each year but what if they need more? You don’t want them hitting the IRA and taking out more taxable income and especially if it is a Roth IRA breaking into tax free money. So the life insurance can provide them extra money in addition to the minimum withdrawals so they can stick with the minimum withdrawal and any other money they need is the tax free life insurance money. This will keep their income taxes lower because the excess IRA distributions would have been taxable. 20:00 The money they use from life insurance is tax free. Also this allows them to stick with the stretch IRA schedule instead of depleting the IRA balance before its time. And it is even more powerful for a Roth IRA. This can also allow inherited Roth IRA’s to last longer and continue to grow tax free for your beneficiaries.

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Life insurance can also be used to simply create wealth. Your family can simply end up with millions more than you ever had all tax free. That’s why when I talk to clients I give them this scenario.

1/ First like I said before we find their net worth. The entire value of your estate. And then I ask, if I could create a plan so that after you die your family will end up with your entire net worth, whatever that is, or much more, would that be a good plan? 20:51  Of course it would be a good plan. Who wouldn’t want that?

Does that mean there were no taxes or other expenses that depleted the estate? No. But we planned for that. And those items can be paid from the additional tax free life insurance money with plenty more left for your family. That’s how any families assets can be leveraged with life insurance to eliminate the effect of taxes and turn what was a taxable estate into a much larger tax free estate.

Here are some other uses for life insurance planning. If you have no retirement you can actually create one with life insurance and have death benefit protection too. 21:31 All guaranteed by moving taxable money into your permanent life insurance policy. This provides a lifetime benefit for you.

Life insurance can be a pension alternative too. Providing beneficiaries with a tax free stream of cash for the rest of their lives similar to the stretch IRA except the life insurance is better than a stretch IRA because it’s tax free.

And another benefit. Money solves a lot of problems. And not just money problems. Families that don’t get along. And it’s not usually your children, it’s the ones they marry. We had a case where one of the daughters just wouldn’t even talk to the other three kids so mum came to see me and she decided to take out $500,000 of life insurance naming the four children as equal beneficiaries. When mum died it didn’t matter that one of the daughters wasn’t talking to the others. Life insurance does not pass through a will. It is not subject to probate or income tax. So each of the children got their $125,000 cheques with no fights and no contact. It is sad but it avoided a ton of legal problems, will contests and other expensive and nasty arguments. They just got the money straight out. 22:45

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 As tax rates increase, tax free becomes much more valuable. Life insurance like Roth IRA’s removes the uncertainty of what future tax hikes could do to your retirement savings. But is it all good? What’s the downside? Nothing is all good. What’s the downside? You might not qualify if you are too ill. You might want to look into annuities for that. That also gives you a guaranteed stream of income for life. (Might I suggest also, owning life insurance on another’s life). Another down side, well obviously you have to commit to funding the policy. If you don’t put the money in you won’t have it. You also need to have funds available to invest. (Blog owner addition – we show you how to use your life insurance to help you invest in a safer manner) But that’s where your IRA and other taxable funds come in. But if you don’t have it maybe it is not for you. Life insurance may not be for everyone. You don’t want to go broke with it. If you don’t have enough assets you probably don’t have a tax problem 23:46 and then it may not pay for you. Maybe you only need enough life insurance to protect your young family from an early death; that you should always have.

The bottom line is that life insurance provides tax free cash. Tax free is always the best source of money and also solves lots of non-tax problems. 24.05

Well, this is all good but people make mistakes when it comes to life insurance planning and understanding life insurance.

Here are the five most common life insurance mistakes:

Mistake number 1/ Thinking that Life Insurance is a cost and looking at it as an investment. If you put money in a bank account that’s an investment. This is the way you should look at life insurance. You want to put it in as an investment, 24:30 and the bigger the number the more you will have. It’s not a cost it is your money. It is not a cost it is an investment.

Mistake number 2/ Trying to pay the lowest amount for life insurance. It sounds good right? Do you want to pay $1,000 or $10,000 for the policy? With permanent life insurance you might want to pay more. Like I said in item one, think of it like a bank account. You might want to maximize the amount you have available, so you might want to put more in.

Mistake number 3/ Not understanding the benefits. Now I went through some of the benefits before. Now let’s review them. a) Tax Free payout after death. b) Generally it’s judgement proof. c) Lifetime access to cash value tax free so it won’t increase your income. It won’t cause social security to be taxed. You won’t lose tax benefits because your income increased like losing exemptions, deductions and credits. d) Life insurance is exempt from estate tax if it is set up right. e) and with life insurance you get guarantees, removing stock market risk. The government has restrictions on how much you can invest but you generally want to put in the maximum you can.

Mistake number 4/ Improper ownership. 25:45 Don’t own it in your own name. Why on earth would you want to own something like life insurance that you cannot possibly collect on? Keep it out of your estate. We see this all the time with clients. It is one of the biggest mistakes made. In fact we had a young couple come in recently, very successful couple, made a lot of money and we were going through the assets they had and the husband actually did have 5 million of insurance. When I looked at it it was owned in his own name. I said what did you do that for. Do you realize that if you die that 5 million comes back right back into your estate and if your estate is subject to estate taxes the government could get half of that. Why would you own it in your own name? You want to keep it out of your estate. I told him go back to your insurance agent and fix this. It’s not that easy to fix but it can be fixed. There are waiting periods but go back to your insurance professional. When I said that he said I don’t even remember who sold this to me. So this just an aside, don’t you think you should have a better relationship with your insurance adviser? You shouldn’t own it in your own name, it should be owned by somebody else or a trust. The life insurance premium should be paid by the beneficiaries or the trustee of an irrevocable life insurance trust so that the life insurance proceeds will be estate tax free. Oh and one downside here, be aware that if you don’t own the policy, which is what I am saying here, you may only have limited access to the cash value because you don’t own it.




Mistake number 5/ Not knowing it is tax free. 27:23 I don’t know if this is a mistake or a misconception. Can you believe it, people still don’t know that life insurance is tax free. I get calls every now and then from a beneficiary that I have done planning for their family for and they’ll call me up and say Ed, I just got this cheque. They say what do I do with it, how much do I owe in taxes. I say I told you a million times, it is tax free. The benefit is so good even when they get the cheque, they don’t believe it.

So let’s review:

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And don’t forget about the most basic life insurance benefit aside from all the estate and tax planning advantages:

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It is hard enough to deal with the loss of a parent but at least life insurance can provide the needed cash so that life can go on without having to make any severe changes due to the lost income. Money for the family, tax free money. I never met anyone who wishes they didn’t have more life insurance, especially a widow. I like to say …….

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You need to review all of these points with your life insurance professional who can fill in the details, but now you are much more informed and ready for the conversation. You might even enjoy the conversation.

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You need to have a conversation with a competent educated adviser, that in addition to being a life insurance professional has the specialized knowledge in retirement tax planning. The coordination is essential, especially if you have built up significant balances in your taxable IRA’s or 401k’s. Most advisers do not have this level of training. Be careful.

As tax rates increase life insurance becomes more valuable than ever before, and there are increases on the horizon. You have new health care taxes coming in as well as higher tax rates. You can plan for that now and if it doesn’t happen, what’s the down side? You and your family have sheltered that much more money since it won’t have to be used to pay taxes. 30:13

Here are some of the frequent questions I get about life insurance.

1/ If the tax exemption for life insurance is so good won’t the government take it away? No. Why? It’s a social reason. Why do you think our govt. encourages us to give money to charity? Because if you give money to charity you get a tax deduction.

Why is the tax code loaded with incentives to encourage us to give money to charity? Why does the govt. want us to give so much money to charities? Because they are broke. So they don’t have to do it. To remove the burden from them. It’s the same thing for life insurance. Our govt. is broke. Our govt. wants us to take care of our own families so they don’t have to. 30:55 They want us to take care of our own family partnered with an insurance company money so that the govt. doesn’t have to.

2/ Next question I get is, Ed, what if I don’t qualify for life insurance? I have to tell you more people do qualify than you think. I’ve seen it even with very ill clients. So don’t assume you won’t qualify. 31:17 Leave this to your life insurance professional to check for you.

3/ How can life insurance companies do this? They’ll lose a fortune. Oh, now you are worried about life insurance companies. Don’t worry about them. They have actuaries. It’s in the numbers. The risk is spread over a large pool of people. Insurance companies are some of the most solid financial institutions.

4/ Next question I get is why doesn’t everyone do this? You know what? I don’t know. I also think that insurance is not sold properly. You look at it as a cost rather than an investment. Many people think they are buying something and they don’t see how it fits into a plan like I have been telling you about. A good financial adviser or insurance professional can explain the planning aspects.

5/ Which is better, saving in an IRA or a Life Insurance policy? 32:16 That’s interesting. Life insurance wins hands down. Let’s compare at a tax deferred qualified plan like an IRA or 401k. If you compare life insurance to tax deferred plans, life insurance has several advantages.

a) Lifetime access to cash value Tax Free and Penalty Free. With an IRA withdrawals can be heavily taxed  and with penalties too. Also with an IRA after you are 70 1/2 you are forced to withdraw and pay taxes whether you like it or not.

b) Life insurance provides a tax free death benefit, income tax free. Estate tax free too if owned properly.

c) With Life Insurance there is no risk of future tax rate increases. I mean they could increase, you just don’t care. 33:09 With a Roth IRA you don’t care either.

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But here is what you don’t get with Life Insurance that you do get with an IRA and 401k, a tax deduction. But a tax deduction these days is a trap because you will pay much more in taxes later.

d) The last question I always get is “come on Ed, are you working for the life insurance companies, this is too good to be true?’ No, I told you that before. I’m here for you telling you how to create and build tax free wealth using the single biggest benefit in the tax code. I always say Life Insurance is the only legal way to print money.

So there you have it, the problems, the benefits, both to you during your lifetime and for your family after your death.

Bottom line, don’t just sit there and admire your IRA or 401k. If you have a large IRA you have a tax problem. It is tax deferred. A sitting duck just waiting to be taxed. Use it, leverage it or lose it to future taxes. Do something now while the best option still exists. Move your money from accounts that are forever taxed to accounts that are never taxed. And good luck.

March 4, 2015 · Jennifer · One Comment
Tags: , , ,  · Posted in: TAXES, Taxes Forever or Never Taxed

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