Many investors do not realize the similarities between many life insurance companies and mutual-fund-type asset management companies. The annual reports and financial statements of many insurance companies show that they are similarly structured to conservative, income-oriented mutual funds with some growth potential.
Insurance companies are experts in risk management. While client contributions are being held for future needs, the insurance company is responsible for investing in a manner that will achieve a safe rate of return.
Still, many people view life insurance only as a necessary evil. The primary purpose of life insurance initially was to create an immediate estate in the event of an untimely death to help cover the economic loss suffered by the beneficiary. The most unique feature of life insurance is that under sections 72(e) and 7702 of the Internal Revenue Code, the accumulation and distribution of cash values inside the insurance contract are tax advantaged.
“Therein lies the beauty of life insurance,” says Chris Kichurchak, president of Noble Financial Group. “It is a unique vehicle that allows you to accumulate your money tax free, allows you to access your money tax free, and blossoms in value and transfers income tax free when you die.”
Smart Business spoke with Kichurchak about life insurance and how it should tie in to your retirement planning.
How can investors use life insurance as a viable alternative for retirement planning?
When properly structuring a maximum funded insurance policy, we need to be cognizant of three tax codes: TEFRA of 1982, DEFRA of 1984 and TAMRA of 1986. These tax codes dictate the minimum death benefit required in order to accommodate the ultimate desired cumulative premium basis.
Let’s say that you have two mutual funds, A and B. Both mutual funds will return 10 percent per year on average. However, mutual fund A has fees of 3 percent per year and mutual fund B has fees of 2 percent per year. Which fund would you rather invest in? Obviously you would want to invest in mutual fund B. If you subtract the 2 percent fee from the 10 percent return then you would net 8 percent per year.
Maximum funded insurance policies can be designed in this manner. Similar to mutual fund management fees, insurance policies have fees, as well. These fees are directly correlated to the death benefit. The higher the death benefit, the higher the fee. If you design a policy with the lowest death benefit possible based on the premium contributions, you can minimize the fees.
During the life of a properly structured policy, fees may be reduced to a point where they only consume approximately 1 percent of the interest percentage credited to the account. Thus, over a 20- or 30-year experience, an investor could very well achieve a net rate of return, cash on cash, of more than 8 percent on a life insurance policy, crediting an average of 9 percent interest.
Going back to the example of the mutual fund that returns 10 percent per year, we net 8 percent per year after fees. However, we still have to pay Uncle Sam. Depending on the type of vehicle this mutual fund is in, the return could be up to 35 percent taxable federally. Therefore, our 8 percent return would only be worth 5.2 percent after taxes, and your tax liability on Social Security earnings could increase.
Is there any way to convert or remove money from IRAs without having to pay the conversion tax?
Unfortunately, we cannot just remove money from our IRAs without paying income tax. However, there is a system to transfer up to $1,000,000 of money trapped in IRAs and 401(k)s with no tax consequences.
Many investors prefer to have the tax-favored protection on the contribution phase, but do not want to pay income tax during the distribution phase of retirement planning. There is a way to indirectly achieve tax-favored benefits during the contribution phase without giving up the tax-free accessibility and transferability later.
Balance sheet control is the key to enhancing net worth. In order to increase net worth, we need to either increase assets or decrease liabilities. Asset control can truly enhance retirement. Some of the assets on a balance sheet can be used to enhance net worth, while increasing the efficiency of a personal income statement. For example, real estate can provide a means for asset optimization. By utilizing the value of real estate, you can multiply your assets exponentially.
What is equity arbitrage?
Through this system, you are able to optimize balance sheet assets and increase net spendable retirement income. Take a real estate asset that can be transformed into two assets: the actual real estate structure and cash. In a positive real estate market, real estate will appreciate. If you separate the cash from your real estate, the cash asset can then be put to work as a second investment asset.
By harvesting this equity, you can arbitrage the cash asset in excess of the cost of borrowing from your real estate. For example, if you take a loan against your real estate at a rate of 5 percent, you could use this cash to invest money at a rate higher than 5 percent.
Distributions from a qualified vehicle such as an IRA or 401(k) are considered taxable income. Therefore, you can offset these distributions with mortgage interest deductibility. Thus, you could remove money from your qualified vehicle with no tax consequences. As long as the returns of your qualified plan meet or exceed the cost of the loan, you will never deplete the value of your account.
The cash that you acquire from your equity harvest could then be used to invest in a tax advantage retirement vehicle. However, these funds need to be invested in a vehicle that remains liquid, safe, and has a strong rate of return. If you use a vehicle such as a maximum funded insurance policy, you can reap returns in excess of 8 percent per year net, and you’ll minimize the taxation of Social Security earnings.
Chris Kichurchak is the president of Noble Financial Group. Reach him at (216) 236-0101 or firstname.lastname@example.org.