Financial security, permanent protection & tax-free cash
Saving more money for retirement is something everyone wants to do.
401(k)s, IRAs, and other qualified plans offer the ability to do so, but for those who are worried about taxes rising in the future, the idea of having to pay taxes upon accessing their retirement accounts is troublesome.
Tax-free retirement accounts, also known as TFRAs, use permanent life insurance that is designed to provide tax-free income for retirement. These cash value life insurance plans are covered under Section 7702 of the Internal Revenue Code, which allows policyholders to fund the plans with after-tax money, grow their cash value in a tax-deferred manner, and eventually access those funds in retirement using participating loans to create a tax-free income stream in retirement.
Indexed Universal Life insurance (IUL) is the type of life insurance most commonly used to design a tax-free retirement policy, though whole life insurance is sometimes used as well.
In a tax-free retirement design, the first step is deciding how much money the participant would like to fund on an ongoing basis, either monthly or annually. From there, the underlying cash value life insurance policy is designed in such a way that a minimal amount of life insurance is purchased for that particular funding amount, while following IRS guidelines for funding.
Important note: Choosing a knowledgeable and experienced agent to design the policy is crucial. Designing for an insufficient amount of life insurance will result in a MEC and the policy losing its ability to generate tax-free income. On the other hand, designs with too much life insurance will limit the policy’s ability to generate maximum cash value.
Once the policy is issued and the first premium is paid, the costs of the life insurance aspect of the plan and any policy fees and expenses will be deducted from the premium payment. From there, all of the money left over gets dumped one or more interest crediting strategy accounts, where the cash value begins to accumulate. Over many years and crediting periods, the power of compound interest works to grow the cash value within the policy.
Once the policyholder is ready to start accessing funds, they can utilize participating loans to generate a tax-free income stream from the tax-free retirement plan. Using the existing cash value as collateral, the participant essentially loans themselves money every year from the policy.
The participating loans aspect of these plans is a powerful one in a tax-free retirement strategy. Since the loaned money doesn’t actually get deducted from the cash value “snowball” which has been accumulating over the years, that money stays in the cash value and continues to earn interest even as the participant is receiving the loaned money from the policy. The strategy is that the interest the cash value “snowball” is earning outpaces the interest that is accruing on the loan side, creating arbitrage.
After years of enjoying a tax-free income stream in their retirement years, all loans are paid back from the life insurance policy’s death benefit once the participant passes away. Any remaining funds left over are then paid out to their policy’s beneficiaries.
The goal of a properly-designed tax-free retirement plan is, of course, to generate tax-free income to be used in retirement. However, participants enjoy a variety of other benefits throughout the life of these plans as well, including:
The younger and healthier the participant, more impressive the results will be. With these types of plans, the more time the money has to accumulate in the account, the better. These plans are most popular with savers in their 20’s through their 50’s. This concept is even popular for parents to start for their children as young as 10 days old. However, these plans can also produce excellent results for older clientele, provided the funding plan is sufficient to produce results.
It’s important to remember that these plans are powered by life insurance policies, and therefore participants must be able to qualify for life insurance in order to utilize this strategy.