A well diversified retirement plan will have three main “buckets”.

          1)            Qualified assets – pension plans, 401k

          2)            Capital assets – real estate, stocks, mutual funds

          3)            Tax free – Roth IRA, municipal bonds, life insurance

Failure to diversify among these three buckets could hurt your retirement income.  With fluctuating tax rates on the horizon, what will happen to your retirement income if all your money is allocated in the “Qualified Plan Bucket” and income tax rates increase.  The answer is simple.  Your income will go down.

 

What will happen if you have all your money in the “Capital Assets Bucket” and capital gains tax rates increase?  Again, the answer is simple.  Your income will go down.  In most retirement plans, the “Tax Free Bucket” is the most overlooked bucket and yet is arguably the most important.

 

The “Tax Free Bucket” may be accumulated in a few ways, most importantly through the use of life insurance.  The idea is to contribute the maximum premium to a life insurance policy with the lowest possible death benefit.  When you pay life insurance premiums, a portion of the premium will be used to pay expenses and the cost of insuring your life.  The remaining premium is placed into a cash value account.  With a large death benefit, a higher percentage of your premium is used to pay the cost of insurance (COI) with a smaller percentage being placed into the cash account.  When you obtain a policy with the lowest death benefit, a very small portion of your premium is used to pay for the COI, leaving a much higher percentage to be placed in the cash account.

 

The cash value account of a life insurance policy is subject to the most favorable tax laws currently allowed by the IRS.  As your premium is contributed to the policy account value, it will grow tax-deferred.  As you reach retirement (or anytime you may need cash), you may then borrow money from the cash value of your life insurance policy completely income tax free.  This is done in the form of policy loans.  With a properly structured policy, loans are automatically repaid upon death by using a portion of the death benefit.  This avoids you having to pay back loans during your retirement.

 

Monthly Contribution (paid to age 65)	Cash Accumulation Value At Age 65	Annual Tax-Free Withdrawals (for 20 years)	Total Tax-Free Retirement Income From Age 66 To 85
$4,000	$2,947,056	$284,555	$5,691,100

In the example above, the urologist has contributed $4,000 per month into an Equity Indexed Universal Life (EIUL) insurance policy. The cash value accumulated at age 65 is $2,947,056.  For the next twenty years, $284,555 may be withdrawn from the policy each year completely income tax free.  This equates to approximately $500,000 per year in a taxable retirement plan.  Even if you die at age 65, prior to taking any distributions, your beneficiaries will receive a death benefit in the amount of $4,160,061 completely income tax free.

Unlike qualified retirement plans, there is no maximum contribution limit.  For the illustrated EIUL policy above, the lowest possible return is 0% in the event of a downward market.  If the S&P 500 returned -20%, the account is credited 0%.  All of your gains are locked in and your investment account cannot be depleted from poor investment returns.  The idea is to protect your investment from loss, while still being able to capture the high rates of return. 

 

These types of plans may be constructed using Whole Life, Universal Life, Equity Indexed Universal Life, and Variable Universal Life policies.  A knowledgeable insurance broker will be able to help you decide which type of policy will best fit your retirement goals.