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Welcome to How to Retire on Time, a show that answers your retirement questions. Say goodbye to the oversimplified advice you've heard hundreds of times. This show is about getting into the nitty-gritty so you can make better decisions as you prepare for retirement. Text your questions to 913-363-1234 and we'll feature them on the show. Don't forget to grab a copy of the book, How to Retire on Time, or check out our resources by going to www.retireontime.com.
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 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 talk about 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 personalized financial advice, then request your wealth analysis from my team today by going to www.yourwealthanalysis.com. With me in this duty today is my esteemed colleague, mister David Fransen. David, thanks for being here today.
David:Yes. Hello, Mike.
Mike:David's gonna be reading your questions, and I'm gonna do my best to answer them. You can send your questions in right now to 913-363-1234. Once again, that's 913-363-1234. Or email them to heymike@howtoreontime.com. Let's begin.
David:Hey, Mike. I'm getting pitched in IUL as a tax free cash vehicle overdoing IRA to Roth conversions. The growth potential is less than an IUL. What am I missing?
Mike:Yeah. So the growth potential is going to be less. There's no such thing as a perfect investment product or strategy.
David:Yeah. We've said it before.
Mike:Yeah. I said it once, said it twice, 3 times, a 1000000 times. But I don't think it's not necessarily what you're missing. It's what do you want? If you can explain what you want, then we can have a conversation about how to get that.
Mike:Many people have heartburn when you say, okay. This is what you want. This is the risk you're willing to take. These are the risks you're unwilling to take. Here's how you accomplish it.
Mike:And they almost wanna say, this is how I want to invest. Here's the result I want, and I don't care that they're incongruent with each other. Mhmm. So if you wanna invest in the market, you're taking some risk. That's okay.
Mike:But you have to understand, you can't pick up one side of the stick without picking up the other. Right? There there are certain things that are just inseparable. You cannot invest in the market without risk. Mhmm.
Mike:That's just how it is. And every investment or product has benefits and detriments. So let me explain kind of some some simple definitions here of Roth, the Roth IRA, and what it is, what it offers, and some benefits and detriments. Let's define things as they are, and then let's define the IUL, index universal life insurance policy, a cash valued policy. It's very different than whole life.
Mike:It's very different than term life. It's just it's its own thing. K? Within the universal life category is you've got variable universal life, you've got universal life, and then you have index universal life. I'm just gonna talk about index universal life because we only have so much time.
Mike:So with a Roth, it's not an actual investment. It's a tax designation on an account that allows you to grow assets and trade and adjust without paying capital gains on the way up, hopefully up, and that you can pull income out as a distribution without paying any income tax.
David:Okay.
Mike:That's it. Yeah. When you say, well, I I need more growth. Technically, you could have a Roth and put it in money market and get around 4% based on today's returns. You know, it might be 1% later on and maybe it's 3% later on.
Mike:Who knows? You could put it on bond funds which historically averaged 4 or 5%. So to say that you're not gonna get as much growth, that's an oversimplification of actual definitions. A Roth is just an account that can defer taxes or or not even defer taxes. It just grows tax free and it distributes tax free.
David:Mhmm.
Mike:It's hard to get money into it. There's limits on how you get money in there, whether it's through after tax contributions in your 41 k or your contribution limits, or you can do the you can do a backdoor Roth conversion or a mega backdoor Roth conversion. Anyway, I digress. But a Roth is just a Roth. Okay?
Mike:How you invest in there is a whole separate thing. And yeah. In point of fact, if you put money in the market, the equities market specifically, you do have more growth potential, but it's not guaranteed. One of the biggest pet peeves I've had is when people say, well, this other guys is saying I could be getting you this. Well, you can't guarantee returns in the market.
Mike:No one controls the market. And this is a common thing that I've heard is, you know, I I'm a single investor or DIY investor, but they keep bugging me saying they can get better returns. Yeah. For more risk, but more risk doesn't guarantee those returns. It just says, hey, they're trying to convince you to take more risk.
Mike:You can't separate the 2. Well, that's what a Roth is. So it's not necessarily you can get more money than an IUL. It just depends on how you invest in it. An IUL or index universal life insurance contract has specific rules associated with it.
Mike:This is according to 7702 of the IRS code. This is current tax law. K? So tax codes written in pencil can change anytime. But life insurance, 1st and foremost, has a death benefit, and you're paying for that death benefit.
Mike:If you don't want a death benefit, you probably don't need an IUL. Mhmm. Let's be very clear about that. Why would you pay for something you don't need? Yeah.
Mike:You know, I I love those budgeting apps where it says you you keep paying for this, but you've never logged in. Yeah. Cancel those subscriptions. Right? So now you all has a death benefit because you're buying life insurance.
Mike:It's principal protected, so the cash value can't go backwards except for with fees, because, again, you're paying for that death benefit. But it can't go backwards, so it's principle protected in some sense. Now it's probably not gonna make as much when the markets go up, but can't go backwards. So it's kinda like in that sense a way to I mean, it could be used as a reservoir. It could be used as a bond alternative.
Mike:It could be used as a CDL alternative, kind of in that sense. It's not an apples to apples comparison, but it's a way that you could put money into something that can increase in value tax free. You can take a loan against it, so pull some money out of it. In that sense, it's technically you're borrowing against the policy tax free. So that's what a lot of people will use this for is for tax advantaged tax strategy.
Mike:Doesn't make it perfect. A little bit less on the upside. Can't go backwards. There's fees associated with it. And with universal life, by the way, let's talk about the fees for a second.
Mike:Because in the illustrations, they don't actually show you the fees unless you ask for it. Like I have to go out of my way to ask for the fee schedule to show them what they're paying, why they're paying it, and how much that is. You don't wanna gloss over that. So for IULs, you have to fund it over a certain period of time. So let's say 5 years or 10 years of equal payments.
Mike:The fees are high in that time. You're not making much money and IUL is a long term situation. So if you're 70 years old, I don't know why you would ever do it IUL. The fees are gonna be higher. You probably won't be able to use the tax benefits.
Mike:It might be better just to put money to a Roth. But if you're 40 or 50 years old and you've got time to slowly put money in here, it could be a very effective part of a portfolio. Let's talk real quick about how the money works. This is also important. So when you take money out, you don't actually take cash out of the policy.
Mike:What you're doing is you're taking a loan against the policy, against the cash values. This is a little complicated. You can listen this over and over again via podcast. But say you have a $100,000 cash value in an IUL. And then let's say you take a loan against the policy of $10,000.
Mike:Are you with me so far?
David:Okay.
Mike:A $100,000, you take $10,000 out. If the account or the policy were to grow by 10%, do you get $10,000 because there's a $100,000 cash value? Or do you get the $9,000 increase because you took out that 10,000? So it's 90,000 in some sense net of withdrawals.
David:Okay.
Mike:You get $10,000 not $9,000 because it grows off of the gross cash value. You didn't take cash out. You borrowed against it. Right. So then what what's with the loan?
Mike:Well, it's a loan. So there's a rate to it. Let's say it's 4%. Okay. So what's 4% of the $10,000 you took out?
Mike:That's $400. Okay. So it cost you and this is the complicated part and this is where people struggle to wrap their heads around it because this is complicated. But in some sense, the policy was able to grow by $10,000.
David:Okay.
Mike:You had an expense or a fee of $400,000 because of the loan. Uh-huh. But you had a $1,000 increase of money you've already spent. So that's a $600 positive arbitrage situation. You see that?
Mike:So this it gets so complicated but this is how people use it. Yeah. So of the $10,000 you took out, you made a $1,000 of money you'd already spent because you took a loan out of the $1,000 you made an increase of money you already spent. You paid $400 in loan fees. So you made $600 on money you've already spent.
Mike:But the catch is if the markets go down, you're still paying the loan, but there's no increase.
David:Right.
Mike:There's no such thing as a perfect investment product or strategy. They don't just waive the loan and say, oh, it's okay. No. They're
David:So there is some risk of doing this.
Mike:There is risk. And many people will over leverage their IULs, and it can blow up in their face. Uh-huh. So you gotta be careful. It's not guaranteed for life.
Mike:It's not an annuity. It is a way to put money into a vehicle that has a death benefit associated with it that can grow cash value. Because they front load the fees for the 1st 10 years, and then the cash can grow. That's the compelling argument for them.
David:Uh-huh. K.
Mike:And there's no limit. You could put as much as money as you want in here and it's fine. Whole life, they kinda spread the fees out. That's why whole life's kinda boring.
David:Oh. Why do you wanna take a loan out? What do people usually use that loan money for?
Mike:So people will use the loan, against the policy to do things like let's say you have a beneficiary IRA. You can't convert that to a Roth. So you could slowly withdraw each year of the 10 years, money out, not pay the taxes on the beneficiary IRA withdrawal, put it into the IUL, and then have the IUL pay the taxes later, hoping that you get some positive arbitrage and make money on the taxes that you paid. Uh-huh. That's one strategy.
Mike:Another one is I know people that will fund an IUL with the assumption that taxes will probably go up in the future. So as taxes go up in the future, they're using the IUL to help absorb the increased taxes because their pensions will go down. Right? A pension's taxes income.
David:Okay.
Mike:So as the pension goes down, they can help absorb that tax by paying the tax from the IUL and hopefully through positive arbitrage, you can get some of your money back. Some people just say I wanna put money in here for a Roth alternative in case they change the tax law for Roths. Mhmm.
David:I
Mike:don't think that would happen. That's a fear based marketing tool that people will use to sell these things. And I also know people that say, I I do like the Roth component or the tax free component to it, but look, we're young. We want a death benefit also at the same time. We're willing to pay that that fee associated with the death benefit because we're gonna delay our social security.
Mike:And if one of us goes, that allows a lump sum money to go to the surviving spouse to offset the missed opportunity of the social security they would have received. So there's all sorts of different ways that you can incorporate this as a part of a plan. But notice the keyword there as a part of a plan. Do not put all of your money into an IUL. Don't go extreme on anything.
Mike:It's all about understand that you plan first, you explore the strategies that you need to implement second, And then you explore how to design your portfolio, 3rd. And this was a very quick explanation of how they work. Look up my Kiplinger article, retirement planning with life insurance. It kinda breaks it down in a nice easy to understand way. But they're complicated.
Mike:They might be right for you. They might not be right for you. One last tip on the IULs, by the way, is if you want cash growth, if that's one of the primary objectives, you want the death benefit there, but you want cash growth, Drop the death benefit after funding. Now whatever insurance agent you're working with to get this IUL, they will lose out on commissions if you do this. The higher the death benefit, the higher the commission.
Mike:But after funding, you can drop the death benefit, and you have to work with the insurance company to do this. So you don't drop it too much. You have to still follow the parameters of code 7702 of the IRS code. But you can drop the death benefit which lowers fees because there's less risk to the insurance company. If there's less risk to the insurance company, then the fees are lower.
Mike:If the fees are lower, the cash can grow at a greater rate. But the reason why you would do this isn't to maximize the cash growth. If you wanna maximize growth of money, you go to the Roth. If you want a death benefit and a way to fund a reservoir that's principle protected, so if the markets go down, you can draw income from it, that you have something that can help absorb some of the taxes in the future, that you can have something that has the potential of that positive arbitrage, then maybe it's right for you. But what do you want?
Mike:Then we can explore what it takes to get there. 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.