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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.
Hello, and welcome to How to Retire on Time, a show that answers your questions about all things retirement, including income, taxes, Social Security, health care, and more. The show is an extension of the book, How to Retire on Time, which you can grab today on Amazon, or you can go to www.how to retire on time.com to get the book and some bonuses as well. 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, an insurance agent, and a tax professional, which means when it comes to financial topics, we can pretty much discuss it all. Now that said, please remember this is just a show.
Mike:Everything you hear should be considered informational, as in not financial advice. If you want personal financial advice, at least if you want it from my team, you can request your wealth analysis at no cost by going to www.yourwealthanalysis.com. With me in the studio today is my esteemed colleague, mister David Fransen. David, thank you for being here.
David:Yes. Thank you. Good to be here.
Mike:David's job, you got an important role, is to read your questions, and I'm gonna do my best to answer them. You can send your questions in now or later, but just save this number, 913-363-1234. That's 913-363-1234. You know what's fun is you can submit those questions anytime in the week. We collect them all, and then we address them on the show.
Mike:So you can send them in 913-363-1234 or email them to hey mike at how to retire on time.com. Let's begin.
David:Hey, Mike. How do you do tax planning with a pension?
Mike:Oh, I love this question.
David:Alright. So Dig into this.
Mike:It seems impossible. So for everyone just to understand a pension is typically taxed as income. There are some pensions, like, for our our military that on disability, for example, they might receive a pension tax free. But for the most part, pensions are taxed as income. So if inflation gets away, your pension gets lower.
Mike:That's our pension risk. If taxes go up, you get less out of your pension as well. K? So most would say it's not possible. Some would venture and say, well, it's possible, but it's a pension versus lump sum analysis.
Mike:And usually what happens is they'll say, well, you know, here's what your pension is. If you get the lump sum, here's what it would be, and we can then convert that over a couple of years into Roth and then turn on an income stream from an annuity. You could say, well, here's your pension. We can put in a portfolio and slowly do conversions of that and then draw 4% out each year, and then kind of this is a similar thing. It's just not guaranteed for life, but you've got control of it.
Mike:So I've seen that conversation as well, and that is a true statement, but you assume the risk In the lump sum analysis situation, if you do an annuity, you may take less income than your pension originally offered. I think back at the Florida pension study, that's not the actual title. I don't don't know what the actual title is, but the state of Florida basically went out and said, hey, everyone. We're thinking about doing a 401 k for you all. What do you think?
Mike:And over 95% of people said, nope. We'll take the pension.
David:Right.
Mike:Pensions are are nice. They're for the most part secure, especially government pensions are pretty secure. Some private pensions are under stress. Some are fine. But for the most part, pensions are taxed.
Mike:So there's one strategy that I came up with that creates tax efficiency with a pension. This is so unconventional, but the math seems to work beautifully. Okay? I'm almost hesitant just to say it over the airwaves because I don't want someone to take this out of context. This is a very complicated strategy.
David:Okay.
Mike:There are a lot of exceptions to the rule. Do not take this as financial advice. Do not take this as a recommendation. Can I be more blunt about detriment and disclosures and Yeah?
David:We got it.
Mike:But I don't wanna be muzzled in the conversation. I wanna explain real strategies that many people don't know exist. So you can use life insurance to help absorb the taxes from your pension. Let me explain. It's a very confusing situation.
Mike:First off, you never buy life insurance unless you also want the death benefit. Okay? What do we mean by that? All life insurance has a death benefit that you will pay for. You can't get around it.
Mike:You can have a smaller death benefit and pay less, but it is not suitable, as in it's not appropriate, to buy life insurance if you don't want the death benefit. So let's be very clear about that. But some people might have a pension that has 0% survivability. So there's a spousal risk. So in that situation, maybe this makes sense.
Mike:You can fund a life insurance policy over 3 to 5 to 10 years depending on how it's structured, and then drop the death benefit and let it grow. And if you can do this, especially if you have 10 years before you take the pension, it's even better. If you don't have that kind of time frame, 5 years or 3 years, it still can work. But you fund an index universal life insurance policy, the same amount over 3 to 5 to 10 years depending on the policy, the structure, and all of that, and you're able to put cash into it that can grow the cash value can grow tax free, you can borrow against the policy tax free. Okay?
Mike:And then the death benefit goes to the beneficiaries tax free in both situations as long as it's going to the right place in the right way. People can run into issues by having the too much of a death benefit going to the estate plan, and then you go past the estate plan exemption, and anyway, taxes. It's important. But with an IUL, this is the the interesting part. When you are generating income from an IUL, you're borrowing against the policy.
Mike:You don't actually take cash out. And the money you take out of a policy has a loan against that. Okay? So let me explain all that differently. Let's say you've got a $100,000 cash value in a life insurance in an IUL, an indexed universal life insurance policy.
Mike:Okay? And let's say you borrow 10,000 out of the policy. The net of loan cash value is 90,000. Are you with me so far?
David:Yeah. Yeah. Yeah.
Mike:Let's say then the benchmark index crediting strategy, how how the thing is gonna be able to grow, increases by 10%. You would assume that it's gonna grow at $9,000 because 10% of 90,000 is $9,000. Not true. It grows off of the gross cash value, the $100,000 that's in.
David:Okay.
Mike:So you get $10,000 of cash value in growth increase, not 9,000. So in other words, you borrowed $10,000, it grew, and you got an extra $1,000 from the money that you borrowed against it. K? And then let's say the, the $10,000 has a 3% loan. I'm just using very general terms here to try and illustrate a point.
Mike:The $10,000 has 3% loan, so $300. So you borrowed money, You paid $300, but you got a $1,000 out of it through what's called positive arbitrage. Yeah. Yes. This is complicated.
Mike:But just because it's complicated, doesn't mean you should avoid it. So in that situation, you netted $700 back from the $10,000 loan. K? Yeah. The reason why this can work, if you figure out how much the pension is, k, how much the taxes are expected to be throughout your your lifetime, and that has to account for the other income streams, the other taxable events happening, but you figure out what that tax burden would be in the pension, and then you use the IUL to pay some or all of the taxes through positive arbitrage.
Mike:As long as the markets cooperate over the long term and you don't overstress the policy, you don't borrow too much from the policy, you can actually, in some sense, make some of the money back from your taxes. This doesn't always work. It's not a fit for everyone. You've got to be young enough. You've got to be healthy enough.
Mike:You've got to have enough time to fund it correctly. You've got to manage the policy correctly. It is complicated. It's extremely complicated, which is why I think a lot of people shy away from using IULs in tax planning as a secondary reason. So the primary reason would be for the death benefit, secondary reason for tax efficiencies.
Mike:But those who have the depth of knowledge on how to do this correctly can absorb a significant part of the tax burdens from their pension, lowering their tax risk in the future. So if taxes go up, this can absorb that so you still can maintain your overall quality of life. Does it always make sense? No. But it's a really interesting strategy for some people in certain situations.
David:Yeah. And if they have someone that they that they trust to sort of guide them through this, and then, you know, maybe it makes sense. Yeah. Need that help.
Mike:Yeah. And if you wanna understand more about how this is, I'm happy to spend time with you one on one about it. First off, to see if it even makes sense. Yeah. It may not make sense.
Mike:But if you wanna explore that, if you wanna look for efficiencies within your your pension and so on, just go to www.yourwealthanalysis.com. Right now, request your wealth analysis, and we can do an analysis on your pension, the pension versus lump sum, and the pension with an IUL, and other options too that may exist just to try and plan around potential tax increases in protecting your income, your quality of life, basically your lifestyle plan. Go to www.yourwealthanalysis.com today, Request your no cost analysis, and we'll have that conversation and really explore if it's right for you or not. Again, www.yourwealthanalysis.com, or you can text keyword analysis to 913-363 1234. Again, that's 913-363-1234.
Mike:That's all the time we've got for the show today. If you enjoyed the show, consider subscribing to it wherever you get your podcast. Just search for how to retire on time. Discover if your portfolio is built to weather flat market cycles or if you're missing tax minimization opportunities that you may not even know exist. Explore strategies that may be able to help you lower your overall risk while potentially increasing your overall growth and lifestyle flexibility.
Mike:This is not your ordinary financial analysis. Learn more about Your Wealth Analysis and what it could do for you regardless of your age, asset, or target retirement date. Go to www.yourwealthanalysis.com today to learn more and get started.