Sometimes in my practice, I get stuck chasing after the next exciting sales concept to present to my client. But as the saying goes, I need to be reminded of proven strategies more often than they need to be instructed on new concepts. Such is the case with this life insurance sales idea – it’s not new. In fact, it is one of the first real life insurance sales concepts that I learned when I entered the industry. Unfortunately, I stand guilty myself of chasing after the next promising strategy and not utilizing this concept to its full potential with my own clients. Today, I would like to show you how to convert your clients’ IRAs to life insurance – and how that policy can then pay all of your clients’ taxes.
Now, before I create a compliance nightmare, you must know that there is no way you can actually transfer qualified dollars directly into a life insurance policy and avoid the taxes. It simply isn’t possible. And this should go without saying, but you can’t actually pay your clients’ taxes for them. That’s called rebating. But, what if there was a way to generate a guaranteed source of wealth that would more than offset the taxes of a single large transaction from an IRA? What if that same policy could offset taxes while also providing safe and moderate growth linked to one or more stock indices? Isn’t this exactly what a modified endowment contract does?
Think about it. Your client, John Smith, decides that he doesn’t want to pay the taxes on his IRA down the road because he dreads the thought of his investments being taxed at ordinary income rates. Many people think that taxes are going up, so what are the clients’ options? Well, that depends. One option is to convert that IRA to a Roth IRA, but every dime you pull out of that account will be taxed as ordinary income. Similar to a cash value life insurance product where you slowly fund the policy over time, you are turning that money from “forever taxed” to “never taxed”. The bottom line: One way or another, the client is going to have to pay taxes on that money.
Another option is simply to move that money into a brokerage account. The benefit here usually comes when the client is looking to access their money before age 59½, or if they desire to make larger contributions to the account in the future. This money is taxed on the growth, which isn’t quite as attractive as never being taxed again – much like in a Roth. When flexibility matters most to the client, this may be a better alternative. Both of these strategies are appropriate when the client is looking to generate an income stream from their investments in retirement.
So, what about the client who wants to offset their taxes guaranteed and generate some safe and reliable growth? Lets look at this example of a 60-year-old male who has $500,000 in an IRA. If he were to take a lump sum distribution,
this would throw him into the highest tax bracket. Assuming a 35% tax burden, this move would cost him $175,000 in taxes, and leave him with only $325,000 in cash.
SALES IDEA #1: HOW TO USE THE DEATH BENEFIT TO PAY TAXES DUE ON AN IRA.
Now, assume that same 60-year-old client placed the same $500,000 in a single premium Indexed Universal Life (IUL) product with a No-Lapse Guarantee to create a Modified Endowment Contract (MEC). Using a competitive product with today’s assumptions, this would buy a death benefit of over $675,000 guaranteed for life, and, in effect, give him TWICE the amount back that he paid in taxes upon death.
$175,000 paid in taxes
$675,000 in death benefit
SALES IDEA #2: HOW TO GUARANTEE SAFE, INDEXED GROWTH
Now that we have established how the client is going to pay the taxes he owes on his IRA, what about the growth he wants? That’s where the indexing part of the policy comes into play. Traditionally, MECs have been utilized for wealth transfer mainly related to the death benefit and cash-value life insurance policies for their growth. But when looking for the middle ground between these two policies, a MEC tied to an index is often an ideal solution. In this same example, when $325,000 is indexed to the market at a 7% index rate, the cash value in year ten is nearly $475,000, and the death benefit has grown to nearly $825,000. By life expectancy, the cash value has grown to over $1.2 million, and the death benefit to over $1.5 million. Now that is impressive.
This begs the question, when is this strategy appropriate for your client? Simple. Look for three things that should
be present for this strategy to be highly attractive:
- Your client has money in an IRA and they don’t want to pay taxes on that money.
- Your client is interested in wealth transfer, but may need access to their money in the future. If cash and income is a priority, think about pulling the money out over 5 or 10 years. The death benefit will not be as great, but the money will be accessible tax-free. If wealth transfer is the only concern, look for a single premium into a guaranteed UL with no cash value.
- Your client is healthy.
When your client is looking to accomplish a wealth transfer in a tax-efficient manner using their IRA, but they also want access to cash if needed, a single premium into a MEC IUL may be one of the cleanest and most powerful strategies in the industry.
You are reading one of the most important tools you will need to be able to maximize your Social Security benefits. It is critical you learn these facts, so that you understand how important the rest of this article is to the decision you will make about claiming Social Security.
The Social Security Administration provides you with:
- 567 ways to claim your benefits
- ZERO employees to advise you on the best strategy
- One chance to get this right (after twelve months, there are no “do-overs”)
While this article and our website will equip you with much of the information you need to know and understand about Social Security, they cannot replace a personal meeting with a qualified advisor. Your visit with us can take into account your full retirement picture so that we can provide you with a Social Security Maximization Report that is built specifically for your situation.
The information in this article is taken from Dr. Laurence Kotlikoff’s article featured in PBS NewsHour, “12 Secrets to Maximizing your Social Security Benefits under the New Rules,” with permission from Dr. Kotlikoff. Dr. Kotlikoff’s article was written in response to the Bipartisan Budget Act of 2015. The views expressed are those of Dr. Kotlikoff and not necessarily Tucker Advisors.
As a young economist, I did a fair amount of academic research on savings and insurance adequacy. At the time, I thought I had a very good handle on the rules. Then I started a financial planning software company, which makes suggestions about what benefits to take from Social Security and when to take them to get the best overall deal. (Ask your advisor about completing a Social Security Maximization Report for your specific situation).
At that point, I realized I needed to quadruple-check my understanding of Social Security’s provisions. To do this, I established contacts with experts at Social Security’s Office of the Actuary. I also hired a specialist whose only job was to audit my company’s Social Security, Medicare premium, and Federal and State Income Tax code.
The problem with this strategy is you can only check on things you know about. Over the years, I discovered things I had never heard of. I would then check with the Social Security actuaries who would say, “Oh yes, that’s covered in the POMS section GN 03101.073!”
Mind you, a large share of the rules in Social Security’s Handbook rules are indecipherable to mortal men and the POMS is often worse. But thanks to patience on the part of the actuaries, I’ve learned things which almost no current or prospective Social Security recipient knows, but which almost all should know.
The reason is that taking the right Social Security benefits at the right time can make a huge difference to a retiree’s living standard.
Unfortunately, Social Security has some very nasty gotcha provisions, so if you take the wrong benefits at the wrong time, you can end up getting the wrong, (smaller) benefits forever.
Also, the folks at the local Social Security offices routinely tell people things that aren’t correct about what benefits they can and can’t receive and when they can receive them. Taking Social Security benefits—the right ones at the right time—is one of the biggest financial decisions you’ll ever make, so you need to get it right.
Getting it right on your own, however, is nigh well impossible. One of my engineers and I calculated that, for an age-62 couple, there are over 100 million combinations of months for each of the two spouses to take retirement benefits, spousal benefits, and whether or not to file and suspend one’s retirement benefits. There are also Start-Stop-Start strategies to consider. Each combination needs to be considered to figure out what choices will produce the highest benefits when valued in the present (measured in present value). For some couples who are very different in age, survivor benefits also come into play. In that case, the number of combinations can exceed 10 billion!
Fortunately, your advisor has access to my proprietary calculator, which can help you find the right answer. It does execute exhaustive searches of all combinations of months in which you can take actions, but thanks to modern computing power and careful programming, our program can run through millions upon millions of combinations of decisions incredibly fast.
Whether or not you meet with your advisor and request your personal maximization report, it’s important to have as full a handle on Social Security’s provisions as possible. Listed below are Social Security secrets I’ve learned over the years that you may not know or fully understand.
1. The most important way to maximize your lifetime benefits was, and remains, to try to start benefits only after they have stopped growing. For a high earning 60-year-old couple, for example—their inability to utilize file and suspend costs them about $50,000. But, if they wait until 70 to collect their retirement benefits, they will still be up $350,000 compared to taking their retirement benefits at 62. That’s the power of being able to wait to collect a 76 percent greater check every month from age 70 through 100 if you live that long. As a result of the Bipartisan Budget Act of 2015, this couple loses roughly $50,000 out of the $400,000 they would have previously received from optimizing. That is, the budget legislation cost them 12.5 percent of their remaining lifetime benefits. The hit to my secretary if she takes her retirement benefit at 66, which appears likely, is roughly twice as large. So this supposed “progressive” policy change that “eliminated loopholes” is nothing of the sort. It differentially forced low- and middle-income households to file for their retirement benefits early and left them with permanently lower old-age living standards.
2. If you are married, you no longer qualify to use the file and suspend strategy. Under this strategy, a) one spouse files and suspends their retirement benefit at 66 and waits until 70 to restart that benefit at its highest possible value, while b) the other spouse files just for a spousal benefit at Full Retirement Age and waits until 70 to take his/her retirement benefit.
Because of the Bipartisan Budget Act of 2015, use of the file and suspend strategy is now eliminated. The spouse who was going to file and suspend had to have been born no later than
May 1, 1950, and had to submit their request to file and suspend on or before April 29, 2016.
3. If you are divorced (after having been married for 10 or more years) and turned 62 no later than Jan. 1, 2016, you can still file just for your divorce(e) spousal benefit at Full Retirement Age and wait until 70 to collect your own retirement benefit.
4. If you are married and you and your spouse are more than four years apart in age, but the younger of the two of you reached 62 by the end of 2015, that younger spouse is still free to file just for a full spousal benefit when he or she reaches full retirement age and still let his or her retirement benefit grow through age 70. This is possible because the older spouse will be taking retirement benefits by then.
5. If you are married and reached 62 no later than Jan. 1, 2016, and your older spouse didn’t reach 66 by May 1, 2016, your older spouse can file for a retirement benefit before age 70, but after you reach full retirement age, permitting you to take just your spousal benefit at that point, and then wait until 70 to collect your own retirement benefit. Whether this is optimal is something only the most precise commercial software can calculate. Make sure that the software program you use has been fully updated since the legislation has passed.
6. Suppose you are a married younger spouse born after Jan. 1, 1954, and that your spouse was born after May 1, 1950. Assume you have very low earnings relative to your spouse, so that your spousal benefit will exceed your own retirement benefit even if you wait until 70 to collect it. In this case, you and your spouse have a tricky problem.
Your spouse can file for their retirement benefit before reaching 70, say, at 68. But doing so comes at a price of permanently reduced retirement benefits, and a permanently lower widow’s benefits for you (if your spouse dies before you and after age 68). On the other hand, by taking his retirement benefit earlier than 70, your spouse can permit you to take your spousal benefit sooner than would otherwise be the case. Recall, however, that if you take your spousal benefit before Full Retirement Age, it will be permanently reduced.
One option, which is likely the best in many cases, is for you to take your own retirement benefit when you reach full retirement age, take your excess spousal benefit when your spouse reaches age 70, and then take his retirement benefit. However, if your spouse has a relatively low maximum age of life, it may be better for you to take your retirement benefit as early as age 62, and have your spouse take their retirement benefit somewhat before age 70 (at which point you would take your excess spousal benefit). Taking the excess spousal benefit (the difference between your full spousal benefit and your own retirement benefit) early (before full retirement age) will permanently reduce it.
But if you are going to be flipping onto a widow’s benefit fairly early in life, getting a bird in the hand may be worth it. If the above sounds even more complex than under the old system, you’re right: it is. The new law has made maximizing your Social Security via the correct collection strategies even more complex for many couples.
7. If you took your retirement benefit before full retirement age, were born after Jan. 1, 1954, and were hoping to suspend it at full retirement age, you can still suspend your retirement benefit and restart it at 70—at what is now a 32 percent larger value. But you can’t provide your spouse, your ex-spouse, or your young or disabled children any benefits based on your account during the years that you keep your retirement benefit in suspension.
For example, you may have filed for your retirement benefit, say, at age 62, to activate a child benefit for your disabled child, and a child-in-care spousal benefit for your spouse who is caring for your child. You may have done so knowing that at Full Retirement Age you could suspend your own retirement benefit and restart it 32 percent higher, at 70, without terminating your child’s disabled child benefit, and your spouse’s child-in-care spousal benefit during the suspension period; Congress and the President just took that option away. When you reach Full Retirement Age–if you suspend–both the child and child-in-care spousal benefit will stop until you restart your retirement benefit. Consequently, the advantage of this Start-Stop-Start strategy has been greatly reduced.
Still, it may be best to forego those auxiliary benefits for four years in order to have a permanently higher retirement benefit (and when you die, provide a permanently higher widow(er) benefit), starting at 70.
8. If you are single or divorced before 10 years, and you aren’t going to get married, the new law didn’t change any of your options except for one. If you didn’t reach 66 until after May 1, 2016, but you still suspend your retirement benefit, you will no longer be able to ask to receive all your suspended benefits in a single lump sum check if, for example, you are diagnosed with a terminal disease. This makes suspending your benefit, in order to raise it by restarting it at 70, a riskier option.
9. If you are widowed, nothing changed with respect to your options to maximize your lifetime Social Security benefits. Your best strategy will be to either a) take your widow(er) benefit at 60 (or 50 if you are collecting disability), and start your own retirement benefit at 70 (or, if widowed, at Full Retirement Age, but you can then suspend it until 70); or b) take your retirement benefit at 62 and take your widow(er) benefit at Full Retirement Age or earlier, in the case your deceased spouse took their own retirement benefit early.
10. If you are collecting disability benefits, you weren’t hurt as badly by the new law. That’s because thanks to another midnight massacre of Social Security benefits, you weren’t able to collect a full spousal benefit off of your spouse’s work record in any case. On the other hand, if your spouse turned 62 by or on Jan. 1, 2016, they can collect just a full spousal benefit from Full Retirement Age through 70, while letting their retirement benefit grow. That is, they too are grandfathered in.
11. If you are disabled, and were expecting to collect excess spousal benefits from your spouse during years that their retirement benefit is in suspension, you won’t be able to receive them unless your spouse was born on or before May 1, 1950, and filed and suspended. If your spouse was a minute too young to meet that deadline, and suspended after reaching Full Retirement Age, they are unable to give you any benefits off of their work records while their retirement benefits are in suspension.
12. If you and your spouse were born before or on Jan. 1, 1954, and have been married for 10 plus years, but neither of you turned 66 before or on May 1, 2016, you have an option to collect full spousal benefits off of each other’s records starting at Full Retirement Age (and then take your own retirement benefits at 70). Know that there is a rather large caveat: The option involves getting divorced two years before you reach full retirement age. Neither of you will be deemed at Full Retirement Age to be filing for both your divorcee spousal benefit, and your own retirement benefit (because you have been grandfathered in), so you’ll have this option that someone who turned 62 after Jan. 1, 2016 didn’t have. Between the time that you divorce and hit age 70, you can “live in sin.” Then at 70, you can get remarried. For some high-income households this can mean an extra $120,000.
Life insurance is first and foremost exactly that—life insurance. Everyone needs it, but most do not know about the vast benefits available to them! The opportunities within indexed universal life insurance are astounding! In a nut shell, it is a Roth IRA on steroids. Let me explain how this works:
STEP 1: Types of Life Insurance
Term Life—Provides a guaranteed death benefit at a fixed payment rate for a limited period of time.
Whole Life—Provides lifetime death benefit coverage for a level premium payment.
Variable Life—Invests the cash value in a wide variety of separate accounts, similar to mutual funds, and the choice of which of the available separate accounts to use is entirely up to the contract owner.
Indexed Universal Life—Combines permanent insurance coverage with greater flexibility in premium payment, along with the potential for greater growth of cash values.
STEP 2: Death Benefit
We start with the cost for purchasing the death benefit. This is the underlying base of the policy. Think of it as a term insurance policy that you invest in for the duration of your life. Life insurance companies have various ways of using the money invested to pay for this death benefit. Some pay out dividends to their policy owners (whole life), while others invest the money directly into the stock market in the hopes of capturing the entire movement of the market (Variable policies.) The companies we work with employ a strategy called indexing that we will explain in just a moment.
STEP 3: Overfund
After the death benefit is covered, the company creates a “bucket” where the owner of the policy can begin to aggressively overfund their policy. This creates an accumulation of excess money inside the policy.
STEP 4: Indexing – The Opportunity
As with any other indexed fund or product, we have a variety of ways to link the excess premiums to single or multiple indices. By indexing, rather than directly participating in the market, we keep the principal safe within the policy. The only risked money is the yield that we spin off each year. By doing this, we eliminate downside risk while still effectively capturing the gains of the market. This money then grows tax-deferred within the policy.
STEP 5: Tax-Free Retirement
Now this strategy really gets powerful! At any point in time you can withdraw money from a policy and pay the taxes on the growth. However, Indexed Universal Life has a provision in them for policy loans—the IRS CANNOT tax these loans. In essence, the goal is to create a bucket of money that grows tax-deferred and will continue to accumulate until it can do three things:
- Continue to link with the market providing constant market growth.
- Still pay the cost of insurance so that no more premiums need to be made in retirement.
- Provide a tax-free retirement supplemental income stream by borrowing against the death benefit!
STEP 6: Benefits of Indexed Universal Life vs. Traditional Savings Vehicle
- No Limits—There are no contribution limits to an indexed universal life insurance policy.
- No Early Withdrawal Penalty—Borrow money to make interest-free purchases before retirement age and pay back the policy rather than the bank for retirement.
- Tax-Free Loans—Completely tax-free withdrawal opportunities.
- Long-Term Care—We can now accelerate the death benefit to provide LTC in cases of chronic or terminal illness. Think of it as reaching into the grave and pulling money back to use while you are still alive!
- Tax-Free Death Benefit—This may seem obvious, but most people do not think about their traditional savings vehicle creating a significant tax problem for their beneficiaries. With indexed universal life, the death benefit is entirely tax-free.
Recently a financial planner sent me a Social Security plan based on a program (I’ll call it program X to protect the not-so-innocent) that he had licensed. The plan was for 60-year-old George and 56-year-old Mary Bailey. The planner asked me to compare the recommendations from my company’s Social Security software program with those from the program he had licensed.
The couple was not particularly special. George was the higher earner by roughly a factor of two, and their age gap was typical. So I was surprised at the big differences in the two sets of recommendations given that I entered earnings histories in my program to calculate the same benefits at full retirement age as the other program was taking as inputs.
By the way, asking users to enter their full retirement benefits, rather than their covered earnings histories and calculating benefits from scratch (as we do in our program) is, itself, a dicey practice. The source of both full retirement benefit and covered earnings histories is Social Security’s website. But Social Security’s retirement benefit calculator assumes zero real wage growth as well as zero inflation – in all future years! These assumptions are fully at odds not just with the entire postwar history of our economy, but also with what Social Security’s Trustees, themselves, assume about the future. Apparently, Social Security wants workers to believe their future benefits will be lower than is the case to get them to save more.
Given that the earnings histories can be copied and pasted into a software program, there seems to be no reason to use a biased calculation of the full retirement benefit. Moreover, if one wants to assume future benefit cuts, the calculator should let one do so directly. The exact earnings histories are needed to implement the Recomputation of Benefits for those beneficiaries who continue to work. They are also need to correctly calculate survivor benefits.
But, I digress as I’ve controlled for Program X’s failure to include earnings histories by entering in my company’s program two earnings histories for George and Mary that produce the precisely same full retirement benefits Program X assumes. Given this, where do the two programs come down?
Both programs advise George to wait until 70 to collect his retirement benefits. But program X has Mary collecting her retirement benefit early at 62 and waiting until age 66 to collect her spousal benefit. While Mary is collecting her retirement benefit, George is told to collect a spousal benefit.
Here’s the statement from program X:
“Mary should file for her retirement benefit in June 2018. George should file for a spousal benefit when Mary files for her retirement benefit in June 2018. George should file for his retirement benefit at 70 in June 2022. Mary should file for a spousal benefit when George is 70 in June 2022.“
Program X calculates the couple’s lifetime benefits at $691,545. Our program has their lifetime benefits at $901,071. If I run our program with program X’s strategy, lifetime benefits are $47,410 smaller. That’s a big difference — roughly one year’s earnings for the Baileys.
Our program has Mary wait until full retirement age to take just her spousal benefit and wait until age 70 to collect her retirement benefit. It has George wait until 70 to take his retirement benefit.
It’s about the planning horizon
What explains the huge difference in lifetime benefits across the two programs? The answer is the planning horizon. Program X assumes that both spouses will die on time – at their life expectancies, which are 81 for George and 84 for Mary. My program assumes both George and Mary will live to their maximum ages of life, which I set to 100.
Assuming that George and Mary will die on time would be fine if they had multiple lives, some of which would end early and others end late. But George and Mary aren’t insurance companies with tens of thousands of insured lives over which to pool risk. George and Mary have only one life each to give to their maker, and they have to worry about the worse case scenario, namely that their maker decides to harvest them at the last possible moment.
This is why the maximum, not the expected age of life is the only appropriate planning horizon. And this is the horizon over which one needs to value lifetime benefits. Stated differently, we need to plan to live to the last possible date for the simple reason that we might.
This proposition comes directly from economic theory, which says that people respond to the risk of dying not by shortening their planning horizon and blithely assuming they will die right on time, but by choosing to consume somewhat more when young and somewhat less when old, if they do end up living longer than expected.
Program X, in killing off poor George and Mary precisely at their life expectancies, is providing no value to all the benefits George and Mary may receive after they exceed their life expectancies. And, as a consequence, Program X is telling Mary to take her retirement benefits sooner than she should, thereby wiping out most of her spousal benefits.
But Program X, which, apparently, was not developed by economists, makes a second, somewhat offsetting mistake insofar as it does no discounting in calculating lifetime benefits. Instead, Program X simply adds up all benefits the couple will receive between now and its life expectance. This treats a dollar received in, say, 20 years the same as a dollar received today. No student of introductory economics would make such a mistake.
To grasp the depth of Program X’s error, suppose George and Mary were considering buying homeowners insurance. In valuing the insurance, the couple would consider the loss they’d incur were their house to burn down and compare it with the cost of the insurance – the premium. They wouldn’t multiply the value of their potential loss by the probability it would burn down. This expected payoff would surely be less than the premium, given the loads involved in buying homeowners and other forms of insurance. With this method of valuing homeowners insurance, no one would ever buy it. But the Bailey’s don’t have a thousand homes, which may or may not burn down and over which they can pool the risk of this occurring. They just have their one house and they have to look at their situation when it burns down and they have no insurance to cover that loss.
My bottom line – not all Social Security advice is good advice. Any calculator that doesn’t explain its choice of planning horizon and its method of discounting (including its failure to discount) is not likely to have the right goods under its hood when it comes to actually sorting out what Social Security does and doesn’t allow and correctly calculating Social Security’s exceptionally, indeed unbelievably complex benefits.
Laurence Kotlikoff is a William Fairfield Warren Professor at Boston University, a Professor of Economics at Boston University, a Fellow of the American Academy of Arts and Sciences, a Fellow of the Econometric Society, a Research Associate of the National Bureau of Economic Research, and President of Economic Security Planning, Inc., a company specializing in financial planning software. An active columnist, Professor Kotlikoff ’s columns and blogs appear in the Financial Times, Bloomberg, Forbes, Vox, the Economist, the Wall Street Journal, Yahoo.com, PBS, and the Huffington Post. Professor Kotlikoff received his B.A. in Economics from the University of Pennsylvania in 1973 and his Ph.D. in Economics from Harvard University in 1977.