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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 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 go 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 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, well, just request your wealth analysis today from my team by going to www.yourwealthanalysis.com. With me in the studio today is mister David Fransen. David, thank you for being here today.
David:Yeah. You're welcome.
Mike:Now David will be reading your questions, which you have submitted, and I'll do my best to answer them. You can send your questions in right now or anytime during the week. Just save this number. Save it right now. 913-363-1234.
Mike:That's 913-363-1234. Or you can email them to hey mike at how to retire on time.com. Let's begin.
David:Hey, Mike. I've been reading about indexed universal life insurance and how it can be a tax efficient income stream in retirement. I can't find the downside. What am I missing?
Mike:Okay. Yeah. The first red flag here is I can't find the downside. There's no such thing as a perfect investment product or strategy. And in this situation, we're talking about a product slash strategy.
Mike:So what are you missing? Well, let's let's talk about it. Let's kind of define what we're talking about here. We're talking about indexed universal life or IUL. That is an insurance product.
Mike:So let's define things as they are. Insurance product, anything insurance related is transferring risk to an insurance company. It should not ever be considered an investment.
David:I was just gonna ask.
Mike:Yeah. Not an investment. An investment is where you're putting money into something that has growth potential. It's part of the business enterprise, so to speak. And whether it's through equity or through debt, you're trying to grow your money through some sort of business exploration or whatever.
Mike:Insurance isn't that. So IULs or indexed universal life are under the umbrella of permanent life insurance or universal life. So you can pay into it for a certain period of time, and then you can stop paying into it. You can also put flexible payments into it. So maybe this year you put in some, maybe next year's a little bit harder, so you can maybe pay a little bit less.
Mike:There's some rules around how much what that structure would look like, but for the most part, it's intended to be a little bit more flexible than your whole life policy. And I'm I'm oversimplifying a lot here, but just for conversation's sake, index universal life, you take money, you put it into the policy over a certain period of time. Remember, it's 5 years, maybe it's 10 years, maybe it's longer. You've you've decided that. And then there's a cash value component that's associated with it that people will use to benefit themselves.
Mike:Usually, it's retirement income. There are other ways you could structure it. But this type of insurance is permanent life insurance. It's not intended to be long term care insurance. Okay.
Mike:Some people mix that up. There are often long term care riders or add ons to where you can access potentially some of your death benefit in advance, but it's not necessarily a long term care policy, as people get that confused, and it's also not guaranteed for life income. So the annuity is defined as transferring longevity risk to an insurance company for lifetime income. So they pool a bunch of people together, they guarantee income for life, whatever that rate is, and it's usually a flat rate, so a flat income stream. And because they've pooled together enough people, and most of them should die off soon enough that they can make money off of this, The few that live long enough, it's okay to kinda pay that off.
Mike:This is not that. There is a cash component that you're taking funds out of it. That can run out. It's based on an index. So if that index is growing, then the cash value grows.
Mike:But if the index isn't growing, in index universal life, it's technically principal protected as in it won't go backwards, but you're still paying the insurance cost associated with this policy. So in some sense, you could say that it will go backwards, but just whatever the fees are. That's kind of the worst case scenario.
David:Mhmm. Okay. I see.
Mike:But it gets more tricky. So if you borrow too much from the policy and the indexes don't increase and the policy doesn't credit enough, over time, it actually can eat away at the policy. And some people leverage their policy too much, as in take too much out of it to where they'll either be required to pay up to keep the policy alive or the policy explodes and it's a tax nightmare. And this is more specifically, I'm talking to those who do premium finance. So they'll they'll insure something on their life, and this is the simple definition.
Mike:They'll insure on their life. They'll borrow money from the bank to fund the policy, and they'll create a system of leverage to try and get more out of a life insurance policy in their name. That's kind of the the oversimplified version of it all. You gotta qualify for that. You must be an accredited investor and that kind of strategy, but normal people can sign up for universal life, for index universal life specifically.
Mike:So there's all sorts of potential issues that you may run into. If you don't manage the policy correctly, if you borrow too much against the policy, you could run into problems. I mean, just imagine that you put all your assets, and don't do this, but you put all your assets into a index universal life insurance policy, because that's your tax free retirement plan. You read the power of 0, which is a pretty well written book by David McKnight about index universal life insurance, even though he never actually says what it is he's talking about. It's index universal life insurance, which he also sells.
Mike:Smart guy, Great book. But let's let's assume you take it to the extreme. You put all your assets into, universal life insurance. Now you've got tax free growth. You've got tax free income.
Mike:But then the index that it's associated with maybe doesn't work out so well. And now you've got to figure out how to keep it alive. You have no more income. These are the kind of problems that people can face if they go too extreme onto these kinds of strategies. How's that for an introduction on on detriments?
Mike:Okay. Yeah. Well, it's funny. It doesn't make it a bad strategy. I I use indexed universal life for very specific situations for tax and estate planning.
Mike:It doesn't always make sense. Sometimes it makes sense. Depends on what the people want. Yeah but I go through all these negatives and then explain how we prepare for that in these situations it's just a tool but everyone can misuse a tool I mean
David:alright
Mike:you could use a hammer incorrectly you could use a screwdriver incorrectly Any tool can be used incorrectly.
David:Sure thing.
Mike:Let's explain how it works. Let's define the strategy itself because I've just kind of beat it up a little bit, and I could beat it up for another hour. Yeah. Really, if we wanted to. Here's kind of how it works.
Mike:And let me know if I lose you because this is gonna get a little bit technical. Okay?
David:Okay.
Mike:So let's say you've got some money and you you wanna fund one of these policies. Here's how the funding would technically work and how you would use it. So you fund it over, let's say, 5 to 10 years. Now why 5 to 10 years? Because if you fund it over a certain period of time with the same payments, it qualifies as insurance.
Mike:So you have those tax benefits.
David:Alright.
Mike:If you drop it all into a life insurance policy in 1 year, you would what they call mecking the policy, modified endowment clause, which basically means that when you pull funds out, you're gonna pay taxes on the gains. Kind of defeats the purpose. Yeah. And then after you funded it, from the day you started till about 10 years or so later, you just don't wanna touch it. Why?
Mike:The cost of insurance is significantly higher, typically, in the 1st 10 years than the rest of the plan. So, like, the first 3 to 5 years, it might be a couple percent. If you if you were to equate it to, like, assets under management being managed by a, you know, adviser Yeah. It's pretty high. It's it's a it can be a couple of percent.
Mike:Now keep in mind, there's a death benefit. So you put in some money and you were to pass, the surviving spouse or the beneficiaries would get a huge lump sum because there's a death benefit. So why is there a cost? Because there's a death benefit. There's a cost of insurance associated with this.
David:Right.
Mike:So there's a reason for the cost, and you can actually open up these illustrations and look at the costs and break it down and look at the actual internal rate of return and quantify it. But after the first usually, it's 5 years or so, then there's typically a decrease in the cost of insurance. And then after 10 years, if you structure the policy right, then the cost of insurance becomes negligible. Let's say, not 1%. Let's say it's, like, 0.1%.
David:Okay.
Mike:Okay? I mean, it it can be very small. I'm not quoting you what could be. Every policy is structured differently. We have to understand how to structure the policy.
Mike:So in in this situation, you would have to know that you're funding, you keep a lower death benefit, and then when you're done funding, you then drop your death benefit. A lot of people don't know you could do this. And if you drop your death benefit, there's less cost of insurance. If there's less cost of insurance, then your cash value has more growth potential. Have I lost you or have I still got you here?
David:I think I still got it. I think I'm hanging around just barely though.
Mike:Basically, you got to structure the illustration correctly. You got to structure the plan and the strategy correctly. Many people even for these companies, I'm telling no do this do this do they they'll say why and I'll say because it lowers this and they go oh. So don't assume that even the people that work for these companies that make the illustrations know how to do these kinds of things. They may not, and as a quick inside tip, the higher the death benefit, the more the insurance agent will get paid.
Mike:So there's an incentive to either not learn or omit some certain things.
David:Right.
Mike:On the higher the cost of insurance, the more the insurance agent will get paid. And so we wanna address those potential conflicts of interest. Alright. So you fund it. Let's say you've got now a 100,000.
Mike:It's been 10 years. You got a 100,000 for an easy number as the gross value at some point in the future. K? But you've taken out throughout the lifetime of the policy around 50,000 of just you've borrowed against it.
David:K? Okay.
Mike:So the net of loan because when you take funds out, you don't actually take cash out. You borrow against the policy. We've got 50,000 of cash value still on the policy, 50,000 of a loan against the policy, but a 100,000 is the total gross amount. Are you with me so far?
David:Yeah. Yeah. Yeah. K. On paper, the 100,000 is the total amount.
David:Right?
Mike:It's the the total cash that was put in because you never actually take cash out you borrow against it uh-huh because when you pass the death benefit settles all these loans
David:okay
Mike:and it makes sense to to not pay it off or not to repay these loans and let me explain why okay So let's say that this IUL is based on a particular index. Whatever the index let's say the S and P 500.
David:Okay.
Mike:And the S and P, based on how the policy is crediting, we you'd get 7% growth in the policy. Now where would that 7% increase? Well, you'd think, oh, well, you know, there are only 50,000 left in the policy because I borrowed 50,000. There's only 50,000 in there, so I get, what, 35100, 7 percent of $50,000. That's 35100 in increase.
Mike:That's not how it works. You would get $7,000 because the growth is the cash value growth is based on the gross amount, the 100,000 of cash that was put in here, not the 50,000 net of loan amount.
David:Okay.
Mike:So you get $7,000, but the $50,000 you've borrowed against the policy has a loan. Let's let's just say it's 3%. I mean, everyone's gonna be different. These loans can also fluctuate, but let's say it's 3%. So you take that loan amount of 50,000, that's a 150 or 1,500 that's taken out.
Mike:Let me break it all up a little bit differently. You've got 50,000 cash value that's in there. That grew at 7%, which would be 35100. Then you've got a 50,000 loan that still grew. Technically, you got the 35,000, then you take away the 100 or 1,500.
Mike:The money you borrowed against the policy still grew by $2,000. This is complicated. If you wanna hear the show again, just go to the podcast or call us up. We can send you a link. Just go yourwealthanalysis.com, kedrec.com.
Mike:It's complicated. I've got some Kiplinger articles about this. But here's the big takeaway. You borrowed money and spent it in some way, but because the cash value, the gross amount, grew greater than the the loan amount, you made money off of money that you had already spent
David:yeah that doesn't usually happen real life right
Mike:well it does real estate this is how you make money in real estate
David:right
Mike:right so you you buy a house right Your mortgage is, let's say, $3,000 or let's say, $2,000. You put some money into it. You bought the house. Yeah. Your mortgage is $2,000 and you charge 3,000 for rent.
Mike:You're making, in some sense, a $1,000 profit plus they're paying the mortgage for you.
David:Oh, yeah.
Mike:And you borrowed from the bank. That's in theory the same thing. This is called Okay. Arbitrage. Now, you got to understand the inverse.
Mike:Let's say you don't get the 7%. Let's say the index goes down, The loan amount is still being taken out of your cash value. You've got to understand what happens when things are good and when things are bad, which is why you don't take too much out of the policy. You've got to leave enough in there for the the times that the markets are bad. You've got to leave enough in there to have flexibility whatever happens.
Mike:It's among the more complicated instruments when it comes to retirement planning. A lot of people don't, in my opinion, really understand how to to do this, how to structure it correctly, how to not let greed take advantage of of taking too much or going too much in the strategy or whatever it is. So you you gotta be careful. Too much of a good thing is a bad thing. Right?
Mike:Yeah. Before we talk about different ways you could use this strategy, I wanna really emphasize one important point. Because this is an insurance product, and it's it's basically built to to mimic an index or to credit you based on an index performance, don't think that you're going to outpace the market with an insurance product. This is very important. Assets in the market have typically more growth potential when you compare apples to apples than you would an insurance product.
Mike:Now assets in the market also have risk, and IUL doesn't go backwards based on the index. It's just whatever the fees would be associated with the policy. So don't think that you're gonna get all the upside and and it's just, you know, this is the best thing since sliced bread. There there are always detriments to something. So you don't want to think that it's it's perfect.
Mike:There there are a lot of very convincing people out there that make this thing look like the perfect investment slash asset class. I say investment with quotes Uh-huh. Because it's not an investment. It's an insurance product. But here are ways that you may use it.
Mike:So let's say you're retiring a little bit younger, or you're just retiring and you're concerned about the surviving spouse and you want a death benefit. You could incorporate a policy like this to help you with some cash flow, some tax planning, but you're also paying for the death benefit for the surviving spouse. Maybe that's important to you. If so, it might work. Unless you need the death benefit, you probably shouldn't even entertain the, this policy altogether, but that's another another conversation for another day.
Mike:Those who don't need to touch it for 10 years, so you can fund it and not need to pull income out for 10 years or tax planning or anything like that, you wanna have this set aside. Those who have pensions and wanna potentially absorb some of the taxes, those who just want principal protection from a source that is tax free, and maybe you don't wanna touch your Roth because a Roth, in theory, would have more growth potential, but you don't want to, be put in a situation where you need to draw income and you draw income from a source that you didn't wanna touch that could put you over the IRMAA limit. So pay more Medicare or too much in capital gains or whatever that could happen. It's kinda nice to be able to borrow against something that can't disrupt your taxes. Yeah.
Mike:Those who have inherited IRAs, this is becoming an increasing problem. Those who are retiring right now, their parents are actually passing right now. That kind of this whole legacy planning shifted because everyone is living longer than expected. So 60 year olds are inheriting right now their late eighties, early nineties parents' money, and they have to pull it out over 10 years and it's pushed them into higher tax brackets. They don't really know what to do with it once they take the distribution out.
Mike:Well, you can't take an inherited IRA and put it into a Roth. I mean, I guess you could do a contribution, but that has a limit to it. So instead, what you do is you take the the inherited IRA and each year, you take it out. The first one or 2 years, you pay the taxes out of it, and you put it into an IUL and you're growing the cash value so that in future years, when you take the distribution out of an inherited IRA, you don't pay the taxes. You put it into the IUL, and then the IUL pays the taxes.
Mike:So it helps kind of absorb some of the taxes as you're inheriting these assets. It goes into a life insurance policy, which in some way you could think about it as legacy to pass things forward to then your kids. So, you know, let's take grandma's money as efficiently as possible, absorb it, and then get more to the kids through a death benefit. That may be what you want. Mhmm.
Mike:It may not be. That's okay as well. And there there's other strategies to your IOLs don't always make sense. It's for very specific purposes, and you have to be okay also wanting to pay for the death benefit costs, and that's all should be broken down in in the illustration. You have to ask for the fee breakdown to get it.
Mike:But this is all it's this is fun. It's fun when you can get this granular and this deliberate and this specific with your strategies and with how you design your portfolio and all the moving parts that are happening over a long term period of time. If you wanna learn more about this, if you want us to check your current life insurance policies, whether it's whole life or universal life to see if it's structured correctly, if there are adjustments that could be made to lower cost of insurance, maybe you're getting a beneficiary IRA and you're looking how to get rid of it tax efficiently. Or maybe you just wanna explore overall better tax planning. Here's what I want you to do.
Mike:I want you to text right now analysis. Keyword analysis. To 913-363-1234. That's keyword analysis to 913-363-1234 or you can go to www.yourwealthanalysis.com today. It's not gonna cost you a dime, but it could significantly help improve your overall quality of life as you explore your lifestyle and legacy potential, as you explore how to get more out of your hard earned money.
Mike:The analysis doesn't cost anything, but here's what it looks like. It's a 30 minute call with me first. That call is to understand what you want. Once we understand what you want, what you expect, what the lifestyle legacy goals are, then we run analysis and visit with you for 60 minutes breaking down what your plan could look like and what strategies you may want to consider. Really, it's to give you a taste of what could be done.
Mike:Many people have found that our analysis is a little bit more comprehensive than their typical retirement plan. And then we go from there and decide how you wanna proceed. And it's okay either way. You could decide to proceed with us and do a DIY. We just we help you out at a flat rate.
Mike:We could do a collaborative where we manage some of your assets, you manage some of your own, or we just do the comprehensive. We just take care of everything. It's whatever is right for you. That's the point. Text analysis right now to 913-363-1234 to get started at no cost and really explore your lifestyle and legacy potential.
Mike:Again, that keyword analysis, text it to 913-363-1234, or go to www.yourwealthanalysis.com today. 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.
Mike:Explore strategies that may be able to help you lower your overall risk while potentially increasing your overall growth and lifestyle flexibility. 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.