The subject for March is tax strategy. Specifically, one of the most common ways Americans save money for retirement and get a tax deduction—the IRA. My hope is that you walk away from this month’s reading with a renewed vision of your future and new ideas of how to get there faster.
To know for yourself whether a financial product is the right fit, you must know more than one perspective. What was your opinion of whole life insurance before meeting with a Wealth Strategist and learning the benefits of a Wealth Maximization Account? There is a lot of misinformation out there about wealth strategy. The IRA is commonly lauded as the must-have retirement account. It is rarely (if ever) analyzed as being a financial tool that may NOT represent the best interest of those who use it.
“Success is achieved by people who deeply understand reality and know how to use it to get what they want. The converse is also true: idealists who are not well-grounded in reality create problems, not progress.” – Ray Dalio
Recently I was part of an investment summit in Pasadena, California. The summit was small and revolved around a group of about fifty investors who were pitched by a handful of start-up companies.
At the end, we were broken into groups of eight and had 15 minutes to create a three-minute business pitch that would be made in front of the group. My group was assigned a technology that would notify parents if a child left a pre-set perimeter while in a public place.
We began, chaotically. The group instantly broke into three separate conversations about how the technology would work.
“Should the device be GPS, Bluetooth, or Beacon technology?”
“Should it be wearable or disguised?
“Guys!” I reluctantly interrupted.
“These are amazing ideas, and if we had more time, I am sure we could figure out how to create the entire business plan. The only thing we need to do is create the three-minute pitch, not the entire business.”
We got focused. We started by defining the problem in simple terms and tied the horrifying feeling of losing a child to the opening lines. We pitched and got an ovation.
It seems that most of us rush to how before ever properly defining the results and their purpose.
My challenge to you is to get crystal clear on the financial results you are REALLY after. When you meet with your Wealth Strategist for your annual review (or more often, if needed), your job is to come prepared with an outline of the results you want and their purpose. Your Wealth Strategist can use this information to help you determine your how.
The Great Recession is now over a decade in our rearview mirror. Many people have seen their IRAs rebound and grow sufficiently with recent stock market gains, improving the level of confidence in being able to retire one day.
The downside of an IRA is that it exposes you to unpredictable taxation, less financial certainty due to market fluctuation, and the possibility of your legacy going to Uncle Sam.
An IRA is structured to offer you tax advantages upfront with your contribution, and tax you at a rate the government determines in the future when you take distributions. If you’re looking for more certainty and better financial strategy, the only way is to prepare now for future tax hikes.
The IRA originated in the mid-70s and began to be utilized by the average American in the early 80s—peak earning years for Baby Boomers. In 1981, the National Debt was $90 billion dollars. Today, the National Debt is over $23 trillion dollars. How is the debt going to be paid back?
There are three ways the U.S can pay down the National Debt:
The United States’s National Debt has increased by $1 trillion per year since 2007. (Donald Trump’s 2021 fiscal year budget projects the National Debt will increase $4.8 trillion.1) We are currently in diametrically different times and being keenly strategic is the only way to navigate what is to come.
United States’s Government Debt: % of GDP
While most countries with a debt-to-GDP ratio of over 77% would be in economic crisis, our country’s debt-to-GDP ratio at the end of 2019 was 108%2 (compared to 2.4% in 1981). A portion of this debt belongs to Social Security and Medicare.
1 “What’s in President Trump’s Fiscal 2021 Budget?”” The New York Times. The New York Times, February 10, 2020. https://www.nytimes.com/2020/02/10/business/economy/trump-budget-explained-facts.html.
2 “United States Government Debt: % of GDP” CEIC Data, January 30, 2020. https://www.ceicdata.com/en/indicator/united-states/governmentd-debt-of-nominal-gdp
The promised benefits of Social Security and Medicare have a future cost of $128 trillion. But the government doesn’t have the money to pay.
Since Social Security’s institution, the government has been borrowing from it to fund increased spending. You pay taxes to Social Security and Medicare to ensure you have income and health care in retirement, but the government is spending your retirement money with no payback plan in sight. In fact, it’s financially impossible for the government to pay this debt.
Funding future Social Security and Medicare costs will be challenging given the handful of options at the lawmakers disposal—cutting other spending, driving economic growth, raising taxes, or financing it (going deeper into debt)—the odds do not look to be in your favor of retiring with a lower tax rate than you currently have.
Future legislation is guaranteed to impact tax rates, for better or worse, exposing your IRA to a huge amount of risk. Remember, IRAs are created and governed by the IRS tax code. Opting to fund other assets that offer more favorable tax advantages, like your Wealth Maximization Account, is one way to mitigate this risk.
Funds in an IRA aren’t leveraged or protected to the same level of funds in your Wealth Maximization Account. Basically, the more money you have in an IRA, the more taxes you pay in the future. The more money you have in your Wealth Maximization Account, the fewer taxes you pay.
As far as taxation on your policy goes, every dollar in cash value is treated as first-in, first-out. This means you can withdraw every dollar you’ve contributed (also known as your basis) tax-free. Once you’ve hit your basis, every withdrawal will be treated as an ordinary income withdrawal, which you’ll be taxed on. But one of the greatest tax benefits of your whole life policy is that you can use that money—beyond your basis—in the form of a policy loan, and policy loans aren’t taxed.
Every dollar you save in a Wealth Maximization Account can be used as future tax-free income for you to spend or future tax-free legacy for your beneficiaries.
When you withdraw from your IRA now instead of later and put those funds in whole life insurance products, you can achieve better long-term planning, protection from future tax hikes, and more certainty in retirement.
In addition to tax security, whole life from a mutual insurance company isn’t exposed to the volatility of the stock market, so you don’t have to worry about the amount of your retirement income plummeting like it did in 2008. The value of your Wealth Maximization Account is guaranteed not to go down.
When the government approved the SECURE Act in December 2019, it changed the way your beneficiaries use you the money you leave behind after death, known as the stretch IRA.
Non-spouses inheriting the funds in your IRA can’t take distributions in perpetuity. They must empty the IRA account in 10 years. This means they have to take distributions in spite of market downturns, rather than only taking distributions when the market is high and offering favorable returns. Effectively, it lowers the amount of your legacy.
In addition to affecting the amount of your legacy, the elimination of the stretch IRA forces beneficiaries to pay whatever tax rate(s) apply during the 10 years of distributions. This can add higher costs for your beneficiaries while raising an estimated $15.7 billion in tax revenue for the government.
With whole life insurance, your beneficiaries receive tax-free income unaffected by the stock market or the IRS. They can choose how and when to use the money you leave as a legacy.
Qualified plans, like the IRA, are cash cows for the government. Your Wealth Maximization Account is a cash cow for you and your family.
Your Wealth Maximization Account is the safety bucket of all your assets. It offers two key ways to optimize your IRA. First, is the covered asset. Second, the volatility buffer.
Because you have a permanent death benefit which will play the role of your legacy asset, you can take larger withdrawal rates on your assets or get the highest withdrawal rate with the least amount of risk using a straight life annuity, which guarantees an income for life regardless of when you pass on. This strategy also reduces your reliance on the market.
With whole life insurance, you can make withdrawals from your IRA when the market is up, and rely on funds in your Wealth Maximization Account when the market is down, giving time for your mutual fund investments to rebound. This strategy is known as the volatility buffer.
A Wealth Maximization Account and an IRA are not mutually exclusive. There can be a place for both in your retirement portfolio.
The question is: Are you putting too much money in your IRA and exposing yourself to unnecessary risk? To find out, meet with your Wealth Strategist. They have financial tools to calculate your ideal strategy, and your strategy may shift as you experience changes in income or set new financial goals.
If you’re over 59 ½: If you’re approaching retirement, whatever that looks like for you, it’s imperative to have a strategic game plan in regards to your future income. You might want to consider putting more of your money in life insurance products and less in your IRA to guarantee the least amount of risk and tax. The Social Security and Medicare benefits you plan to take will have a major impact on how you want to distribute your wealth.
Schedule a free appointment with a Wealth Strategist to calculate the best way to manage these moving pieces.
If you’re under 59 ½: Regardless of when you withdraw money from your IRA, you have to pay taxes. But if you’re withdrawing funds before age 59 ½, you’ll also get hit with a 10% penalty on the amount you withdraw.
Fortunately, if you’re using funds in your IRA for whole life insurance products, you can utilize section 72(t) of the tax code to avoid this penalty, provided you make five equal distributions to a Wealth Maximization Account. This can be a complicated process. It’s crucial to meet with your Wealth Strategist before embarking on this path, to ensure you aren’t penalized.
When determining how large of a whole life policy you need, Paradigm Life recommends a 1:1 ratio. The amount of your assets should equal the amount of your death benefit. If you have a Wealth Maximization Account with a smaller death benefit than 1:1, you may want to consider using IRA funds to increase your death benefit.
If you have a substantial amount of money in tax-deferred vehicles like an IRA, now is a great time to evaluate your finances. An incumbent president historically won’t make changes to the tax code in an election year, which gives you the rest of 2020 to create a game plan for how to best fund your IRA and whole life insurance policies to better protect and grow your wealth and improve your position for next tax season.
Don’t skip your annual review with your Wealth Strategist. It’s more important this year than it has been since our last election year, in 2016. Opening additional whole life policies, funding premiums, or increasing your legacy are just a few of the ways extra money in your IRA could be better protected.
A Wealth Maximization Account is the backbone of The Perpetual Wealth Strategy™