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Welcome to How to Retire on Time, a show that answers your questions about all things retirement, including income, taxes, Social Security, healthcare, and more. This show is an extension of the book How to Retire on Time, which you can grab today on Amazon or by going to www.howtoretireontime.com.
This show is intended for those within 10 years of their target retirement date or for those are are currently retired and are concerned about their ability to stay retired.
Welcome to how to retire on time, a show that answers your questions about, well, all things retirement, including income, taxes, Social security, health care, and more. This show is an extension of the book, How to Retire on Time, which you can grab today on Amazon or by going to www.how to retire on time.com. My name is Mike Decker. I'm the author of the book, How to Retire on Time, but I'm also a licensed financial adviser, insurance agent, and tax professional, which means when it comes to financial topics, we can pretty much discuss whatever's on your mind. Now that said, please remember this is just a show.
Mike:Everything you hear should be considered informational as in not financial advice. With me in the studio today is my esteemed colleague, mister David Frandsen. David, how are you doing today?
David:I'm well. How are you?
Mike:I'm doing well. Great. This is gonna be a good show. And now just for the newcomers, this is how the show works. David will be reading your questions, and I will do my best to answer them.
Mike:You can send your questions in by either texting them to 913 363-1234. That's 913-363-1234, or email them to hey mike@howtoretireontime.com. Let's begin.
David:Hey, Mike. I have a beneficiary IRA from my mom. As I understand it, I have to take money out each year for the next 10 years. That's a huge tax problem. I'm grateful for the inheritance, but I hate seeing that much go to taxes.
David:What can I do?
Mike:Okay. So tax planning is not the avoidance of tax necessarily. You you can't not pay your taxes. With beneficiary IRAs, how it works, it used to be that you could just slowly take it out over your lifetime. You had a lot of runway.
Mike:Now you have to take it out over 10 years. And the idea is, well, how do I just not pay taxes? And we hear about these alleged strategies where, oh, well, if you do this, this, this, you just don't pay any taxes. That's not how tax planning works. You have to pay your taxes.
Mike:It's about how do you strategically alter or adjust or optimize your financial situation so that overall you're paying less in taxes with what you have to work with. And I think that's a big misnomer. Let me kind of give an example. Here are a couple of fancy strategies. K.
Mike:When I say fancy, they're they're more complex, they're more comprehensive, but they're also more risky. So, for example, if you had a big tax event happen, you might consider something like an oil and gas partnership. Now I'm not saying this is good for a beneficiary IRA. I'm just let me walk you through kind of some of the k. The strategies you hear about, but you don't really understand.
Mike:So an oil and gas partnership, basically, you put money into this partnership. And in the 1st year, for example, they purposely lose a lot of money. They spend it all. They make no money. And because the partnership, you should be able to write off that in your taxes.
Mike:You're taking the losses and the gains and trying to equalize it.
David:Okay. Got it.
Mike:That that can minimize it, but there's risk. What if they drill and they don't find any oil? You're out. Uh-huh. But if they drill, they find oil, then over the preceding years, you should be able to get your money back.
Mike:But you've spread out the profits. You've hopefully made your money. But there's risk associated with that. Oil and gas partnerships on the risk spectrum should be on the higher end of risky. But that is a strategy you can implement in some sense to try and minimize your taxes.
Mike:You gotta have it within proportion here. Another one is a qualified opportunity zone, but I don't know anyone that's actually done this before. So the theory behind it is there are depressed parts of the United States, and they are designated as opportunity zones. And so you can take your money, your gains, so the taxable situation of the sale of a home, the sale of a business, a beneficiary, IRA, if you just liquidate it all in 1 year, whatever it is, And you could put that into a qualified opportunity zone, basically defer your taxes, but you still have to pay the taxes in a couple of years. It's just you get a few more years to hopefully grow the asset.
Mike:There's a lot of legalities into what works and what doesn't work, but it can grow tax free and so I mean basically you kick the tax can down the road but can you see how this starts to get kind of complicated
David:it does yeah and then I'm wondering like who's finding the opportunity zone and like who's
Mike:how's it structured? Yeah. You know, what what's the risk? You don't have much control over these situations. It's illiquid.
Mike:And so when you get into fancy tax strategies, they tend to have risk associated with them. Sure. And when someone's retired or near retirement, you may not want to take that risk.
David:Right.
Mike:K? These are things that might be more appropriate if a business owner is selling their business. Let's say they're selling it for 7 to $10,000,000.
Mike:And they're gonna take a chunk out of it and say, well, I don't need all my money right now. So maybe I'll put some into this opportunity zone. Maybe I'll put some into the partnership, and I'll accept the risk. You can divide and conquer. But to go all in on something or to try and just not pay taxes you got to understand there's no such thing as a perfect investment product or strategy there's risk associated with these and and that's a problem yeah you can also go into charitable options So like a CRUT or a CRAT, charitable remainder trust, under that umbrella, you can just donate the funds but then you have no control over the funds.
Mike:So what's the point of receiving a beneficiary IRA that you want to spend when you can't spend it? But some people are are have charitable intent. Maybe they don't need the funds. They can donate, each year and not pay taxes, so the the charity gets all of it instead of the after tax amount. And there are ways to do that.
Mike:But, again, what's the purpose behind this? As I say over and over again, plan efficient port portfolios. What's the plan? What's the lifestyle legacy plan look like? Do you want to use these the beneficiary IRA assets in your lifestyle or not?
Mike:If not, then the tax planning becomes a lot easier. If you do want to enjoy it, then it becomes a little bit more complicated. Then you've got the insurance side of this. So I'm transitioning from fancy tax strategies to gifting, if you just don't need it, to the insurance industry strategy for tax minimization.
David:Okay.
Mike:First off, you need to understand that all insurance products are insurance products. They're not investments.
David:So unpack that like how does that what does that mean exactly like an investment versus an insurance product what makes us different
Mike:yeah so investment means you're putting money into something with the intention of growth You you are investing as in you are saying, I'm gonna give you money, and I want more money in return. But I'm gonna take risk in giving you money for a greater potential. So if I if I give money into a bond investment, and in some sense, you're saying I'm gonna lend you money. That's it's a business transaction of sorts, and you're gonna give me some money back, bonds, like treasuries. It's a low risk or lower risk investment.
Mike:Or I can say, hey. Here's a brand new start up. I'm gonna give you some seed money. I'm going to the other extreme here. Yeah.
Mike:Hopefully, you work out. Could be amazing. Yeah. But you also have an over 80% chance of just failing, and I could lose all my money. So an investment means you're giving money into something where there's a risk and reward potential, and and you wanna get your money back.
Mike:But an insurance product, all insurance products are really defined as the transference of risk to something. So term life insurance, you pay, what, $40 a month if you're in your twenties or thirties at some rate to transfer the risk of death to an insurance company. So the fact that you if you die, they're gonna pay it out, but you don't wanna die. They don't think you're gonna die. And they pull so many people together that the few people that do die, it's unfortunate, but they would then benefit from it.
Mike:But the insurance company overall makes money. The the odds are in their favor. That's how they're priced. That's how they're structured. And so when it comes to permanent life insurance, a lot of people treat this as an investment.
Mike:It is not. And let let me write that down. Permanent life insurance, you're paying for a death benefit. In investment, you're not paying ongoing fees for some sort of benefit. It's just an investment.
Mike:So there's a differentiator that's there. So if you want the death benefit, and you might want it for, let's say you're you've inherited an IRA, and you're concerned about spousal risk, one spouse passing earlier on. Maybe you do want it. Maybe it makes sense to pay for a death benefit. But if you don't want a death benefit, this whole strategy might not even make sense.
Mike:But let me at least share it with you. Because if I explain it here, then at least you'll know what's going on as opposed to someone else where they tell you the benefits but not the detriments. Yeah. So the way life insurance is often used for tax planning purposes is what they'll do is they'll take usually, it's I see an IUL, an indexed universal life insurance policy. That's a policy to where you pay into it over 5 to 10 years, whatever the the payment structure is, and then you don't need to keep paying it.
Mike:K? It has a death benefit associated with it, but the policy, because it's insurance, grows tax free. There's no capital gains issues. You can borrow against the policy tax free. So if you need income or something from it, you can borrow it.
Mike:There's no tax situation. And then when you die, it can go to the beneficiaries tax free. Do check, though, your estate planning structure in your state because there there can be a few estate tax issues if the death benefit's too high or if things aren't signed up correctly but that's not for today's conversation so you've got this life insurance policy you can put money into it it grows tax free you can borrow against it tax free and there's a death benefit that's the basic definition of it
David:makes sense
Mike:now here's how they use it so they will people will take and I've done this too when it makes sense when there's a healthy person who you can have a low cost insurance cost associated with the policy but you can take your beneficiary IRA take a distribution out of it to satisfy your required minimum distribution the amount you have to take out every 10 years put it into the indexed universal life insurance policy, and then borrow against the policy to pay your taxes. Why would you borrow against the policy to pay your taxes? It's because life insurance, specifically index universal life insurance, grows on the gross amount, not the net of loan amount. So let me explain that a little bit differently. If you have a $100,000 policy and you take out a $10,000 loan, you would think that $90,000 is the amount that would grow, you know, because you took money out.
Mike:That's not how it works. The $100,000 is what grows. That's the cash value that would grow, but the $10,000 you took out, right, you borrowed against the policy, is going to have a loan that you have to pay, or there's a there's a percentage of that. So this is called positive arbitrage. It's a rather complicated topic, so going over this through the airwaves is is a bit much, so bear with me, but you need to understand this.
Mike:If your loan of $10,000, let's say it's 3%, and the $100,000 is growing at let's say 8%, and I'm not giving actual numbers here, I'm doing this as a hypothetical example, then why would you ever pay off the loan? Why would you ever give the money back? You're making money off of the money you borrowed.
David:Yeah.
Mike:So the the reason
Mike:why people do this with tax strategy is they can put cash into a policy, borrow against it, and as long as the policy is making more than that loan amount, so the indexed increase that what's credited to the policy is greater than what you're paying in loan. You would never want to pay it off. That way, you can basically take your tax payments and almost make some of your money back, if not all of it back, depending on how long you live. It's a way to use positive arbitrage to borrow against your own cash value, to make your money back. It can be very tax efficient as long as the policy is structured, and this is where the the nuance of insurance needs to come into play.
Mike:So just a few things to be aware of. If the death benefit is high or stays high, that's more of a cost of insurance burden on the policy. It won't grow as much because you're paying for a higher death benefit. Remember, it's not an investment. This is insurance.
David:Got it.
Mike:Yeah. So the trick is that once you're done funding the policy, you drop the death benefit because you're trying to create a lien insurance cost. But if you drop the death benefit the commissions will also be less so it's a tricky situation because how do you know to to look for these things how do you know to request certain things in your illustration as you're creating the policy when you don't even know what you can do. Right. Yeah.
Mike:So life insurance is incredibly complicated. It doesn't always make sense. If you're young enough, if you're healthy enough, and you did receive a beneficiary IRA, you can structure these to help alleviate some of potentially the taxes there, but it gets complicated. And you've got to work with someone that is a licensed fiduciary, so they're legally bound. It's contractually in their their agreement that they're legally bound to put their interest ahead of their own.
Mike:They have to also be an insurance agent because an investment adviser can't give you life insurance. They have to be duly licensed. And you have to work with someone that you believe does their own research instead of just telling an insurance company how to sell a product. They've almost got to be your fight against the insurance company to clarify these things. So all of this is just so important.
Mike:It's highly nuanced, but that's the insurance strategy on how to deal with beneficiary IRAs. It may or may not be right. The other one is if you're still working and you receive a beneficiary IRA, maybe you just max out your pretax contributions, which I think is around 30,000 or so that you can do if you're older than 50 years old. And then take out the beneficiary IRA as just normal income. So you could potentially structure it in a way that yours it's the same amount of taxes you're paying each year.
Mike:It's just your work is putting more into a pretax account, and you're bridging the gap with your beneficiary income. It's an incredibly complicated situation. Most people are just told, well, sorry. That sucks. You gotta pay the taxes.
Mike:That's how it works.
David:Yeah. Right.
Mike:And we're just touching the the tip of the iceberg of different ways you can structure. This is why it is so important to have a lifestyle plan, a legacy plan, and then to dive into the efficiencies before you talk product, before you talk investment, before you talk about where the money should should even go to. You've got to put the plan first then the efficiencies and then the portfolio last
David:makes sense
Mike:that's the quick version of what could be a very long and technical conversation when it comes to tax planning but these efficiencies may be able to get you 1 to 2%, maybe more growth potential through efficiencies. And I don't know your situation. I don't know exactly what it would look like. Everyone's is different, But my goodness, the little differences the devil's in the details. These little differences can amount to significantly more flexibility in the future, possibly more growth potential, possibly paying less in taxes.
Mike:There is there's an incredible amount of possibilities here. If you have a beneficiary IRA, if you think you're gonna get a beneficiary IRA as a part of your inheritance, start planning for it now. Start saying, well, where am I currently investing? What's my current portfolio look like? Start preparing for it because once you get it, the clock starts ticking.
Mike:And if you want help looking into that, go to www.yourwealthanalysis.com right now. Doesn't cost you a dime, but these strategies can make a significant difference overall in your financial situation. That's www.yourwealthanalysis.com, or you can text right now analysis, keyword analysis, to 913-363-1234. That's analysis. To 913-363-1234.
Mike:You'll get a link that'll take you to your wealth analysis.com where you can learn more about this analysis, what it could do for you at no cost, and then how to proceed. Now that's all the time we have for today. If you want more tips about retirement, income, taxes, social security, health care, and more, make sure you subscribe to this show. Wherever you get your podcast, just search for how to retire on time. Also, you can catch this show via our 247 digital broadcast by going to www.retireontimeradio dotcom.
Mike:You can stream various episodes on your phone while you're on the go, in the car, or wherever you are on a run. Just go to www.retireontimeradio.com. From everyone here at Kedrick Studios, thank you for spending your time, your most precious asset, with us today.