Tax-Free Distributions

Tax-Free Distributions

September 28, 2017

One of the biggest problems facing high-income earners today is taxes and it's also a problem for anyone deferring capital gains using a qualified account like a 401k or an IRA since withdrawals are taxed at an ordinary income rate. A solution to this problem is a properly designed Indexed Universal Life policy or IUL. This type of life insurance policy can link your cash value to an index like the S&P 500 without the risk. Your account will participate in a percentage of the index gains yet when the index falls you will not lose any value. 

Tax-free income can be obtained from the IUL by taking tax-free loans against the cash value. These loans work similarly to home equity loans in the sense that the investor does not pay income tax on the money borrowed. Unlike a home equity loan, though, the investor does not have to pay back the loan balance during their lifetime. This is pertinent to tax codes 7702 and 72(e). 

You can actually dump a large sum into an IUL but in doing so you would be creating a modified endowment or a MEC and that would adversely affect your tax-free distributions. So the way to do it as an example using 250k for a 50-year-old male would be to spread it over seven annual payments of $37,870.58 (factoring in 2% interest in the deposit fund) each thus avoiding creating a MEC. In this case, the initial death benefit would be $707,198.00.

There are some companies that allow you to deposit your lump some premium into a deposit account earning 2% interest on your premium while waiting to be applied to the policy. One A+ rated insurance company has a 145% participation rate in an index with NO CAP on the upside. Using the example above of a 50-year-old male with an average annual rate of return on the index of 7.02% (the actual index averaged 7.56%) since current laws don't allow us to use anything higher for an illustration would create tax-free distributions starting at age 66 of $49,023.00 a year. The death benefit peaked at age 65 to $1,040,782.

By age 80 using the same example he would have taken a total of $735,345.00 in tax-free distributions and still have a death benefit of $364,636.00. Keep in mind that only $250,000.00 was put into this policy originally. Contact my office for more information on this type of policy and an illustration based on your objectives.