retirement tax strategies - highnetworthlife · income tax-free . distributions at death. 3 how...

Retirement Tax Strategies for the Affluent

Retirement Tax Strategies for the AffluentUsing Cash Value Life Insurance to Help Create a Secure Future

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Pacific Life Insurance Company

1 Introduction

In this Guide

Social media and online news sites love to publish articles discussing Americans’ reluctance to plan for their retirement. These articles paint a gloomy picture of a future with too little money saved, the possibility of reduced Social Security benefits, and many people feeling they may never be able to retire. While this may be the case for typical Americans, the affluent could have options that might not be appropriate for most people.

You’re likely already paying more in taxes, with a higher marginal tax rate than most. Strategies that reduce your taxes now and during retirement can make the difference between a reduction in your standard of living and financial security. This guide introduces strategies to get you thinking in the right direction and discusses steps you can take to keep more of your money.

1. Introduction

2. Discover Overlooked Assets Which Receive Favorable Tax Treatmenta. The Three Distinct Asset Categoriesb. How to Help Supplement Your Existing Retirement Funds

3. How These Assets Supplement Wealth-Building Strategies and Minimize Tax Riska. Compare Your Optionsb. Diversify to Help Reduce Tax Risk

4. Take Control of a more Flexible Future


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2 Discover Overlooked Assets Which Receive Favorable Tax Treatment

The Three Distinct Asset CategoriesIf you’re like most high-income individuals, you’re probably already maximizing your contributions to the first category of retirement assets, those held inside retirement plans, which includes qualified plans such as 401(k)s and traditional IRAs. But those plans have limits on how much you can contribute, and those limits aren’t designed for people who are making a lot of money. So even if you fully fund them, you still may not have enough invested to afford the retirement you dream of, and you also risk outliving your retirement assets. Plus, the proceeds of traditional plans are generally taxed at ordinary income tax rates when you receive the distribution. Many people assume they will be in a lower tax bracket when they retire, but if you want to maintain your current standard of living that may not be the case. The taxes you pay in retirement can eat up a substantial portion of your savings.

Your retirement portfolio may also include the second category of retirement assets: those held outside of retirement plans, which includes stocks, bonds, and real estate. These assets can provide substantial retirement income, but proceeds are generally taxed at capital gains or ordinary income tax rates. Other commonly-held assets like CDs, savings bonds, and savings accounts are also taxable.

The third category of retirement assets, often overlooked, can receive favorable tax treatment. This category includes Roth IRAs, which can have tax-free distributions; municipal bonds, which can pay tax-free interest; and cash value life insurance, which provides tax-deferred growth, tax-free1 distributions, and tax-free death benefits2. While Roth IRAs are useful, many wealthy investors earn too much to take advantage of their favorable tax treatment, and the amount you can contribute is limited. In a low interest rate environment, municipal bonds may not generate the kind of return you desire.

Distributions generally taxed Distributions generally taxed at capital gains rates

Distributions generally tax free

ASSETS HELD INSIDE RETIREMENT PLANS ASSETS HELD OUTSIDE RETIREMENT PLANS OVERLOOKED ASSETS

1 For federal income tax purposes, tax-free income assumes, among other things: (1) withdrawals do not exceed tax basis (generally, premiums paid less prior withdrawals); (2) policy remains in force until death (any outstanding policy debt at time of lapse or surrender that exceeds the tax basis will be subject to tax); (3) withdrawals taken during the first 15 policy years do not cause, occur at the time of, or during the two years prior to, any reduction in benefits; and (4) the policy does not become a modified endowment contract. See IRC §§ 72, 7702(f)(7)(B), 7702A. Any policy withdrawals, loans and loan interest will reduce policy values and may reduce benefits. 2For federal income tax purposes, life insurance death benefits generally pay income tax-free to beneficiaries pursuant to IRC Sec. 101(a)(1). In certain situations, however, life insurance death benefits may be partially or wholly taxable. Situations include, but are not limited to: the transfer of a life insurance policy for valuable consideration unless the transfer qualifies for an exception under IRC Sec. 101(a)(2)(i.e. the transfer-for-value rule); arrangements that lack an insurable interest based on state law; and an employer-owned policy unless the policy qualifies for an exception under IRC Sec. 101(j).

How to Help Supplement Your Existing Retirement Funds Using Cash Value Life InsuranceMany people don’t realize that cash value life insurance, in addition to paying your policy beneficiaries a tax-free benefit3 when you die, can also be used to provide many important benefits while you are alive. These benefits can help supplement the income you receive from traditional retirement accounts, such as 401(k)s and IRAs. You have the flexibility to choose different products which allow options for how the premium can be allocated, and the cash value accumulates tax-deferred. This means that as your money grows, you pay no taxes on the gains.3 For federal income tax purposes, life insurance death benefits generally pay income tax-free to beneficiaries pursuant to IRC Sec. 101(a)(1). In certain situations, however, life insurance death benefits may be partially or wholly taxable. Situations include but are not limited to: the transfer of a life insurance policy for valuable consideration unless the transfer qualifies for an exception under IRC. Sec. 101(a)(2) (i.e., the "transfer-for-value rule"), arrangements that lack an insurable interest based on state law, and an employer-owned policy unless the policy qualifies for an exception under IRC Sec. 101(i).


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Compare Your Options

UNLIMITED ANNUAL

CONTRIBUTIONSPRE-TAX

CONTRIBUTIONSTAX-DEFERRED

ACCUMULATION6TAX-ADVANTAGED

DISTRIBUTION

INCOME TAX-FREE DISTRIBUTIONS

AT DEATH

3 How These Assets Supplement Wealth-Building Strategies and Minimize Tax Risk

By now, you may be wondering how to incorporate assets which receive favorable tax treatment into your retirement planning. This chart compares various asset types to show how they each contribute to your portfolio.

Traditional IRA5

Roth IRA

Qualified Plan

CD8

Mutual Fund9

Municipal Bond Fund10

Individual Owned Deferred Annuity

Cash Value Life Insurance

4 For federal income tax purposes, tax-free income assumes, among other things: (1) withdrawals do not exceed tax basis (generally, premiums paid less prior withdrawals); (2) policy remains in force until death (any outstanding policy debt at time of lapse or surrender that exceeds the tax basis will be subject to tax); (3) withdrawals taken during the first 15 policy years do not cause, occur at the time of, or during the two years prior to, any reduction in benefits; and (4) the policy does not become a modified endowment contract. See IRC §§ 72, 7702(f)(7)(B), 7702A. Any policy withdrawals, loans and loan interest will reduce policy values and may reduce benefits.

5 Individual Retirement Account6 A Roth IRA allows you to make contributions with after-tax money without current income tax deductions. You pay now and may enjoy tax-free income later, provided you hold the Roth IRA for at least five years and don’t take distributions before reaching age 59 ½. If you do not meet the five years and attaining age 59 ½ requirements and need to take a distribution, you may owe income tax on earnings, and a 10% federal tax penalty may apply to the earning and prior converted amounts. Similar to the traditional IRA, there are exceptions to the 10% federal tax penalty for withdrawals and the age 59 ½ age requirement, such as first-time home purchase, death, disability, certain qualifying medical expenses, health insurance premiums, or higher-education expenses. 7 A distribution from a Roth IRA generally is income tax free if (a it meets all the requirements for a qualified distribution (which include a 5-year waiting period and one of several additional requirements, one being that the distribution is made to a beneficiary on or after the death of the individual, or (b it is a nonqualified distribution to the extent of after-tax contributions (basis. 8 Certificate of Deposit9 Mutual finds may be subject to income tax and/or capital gains taxation. Consult your tax advisor for more information.10 Generally, interest paid on municipal bonds is tax-free, but not all municipal bonds are exempt from federal and/or state income tax. Some bonds may be subject to capital gains tax at sale. Consult your tax advisor for more information.11 There is not a specific limit on dollars allocated to purchase life insurance; however, there are maximum premium limits determined by a specified policy face amount. A policy will qualify as life insurance if it meets the requirements of IRC Sec. 7702, which includes limits on the amount of premium that may be paid into a specific face amount and still qualify as life insurance.12 Upon Distribution, when a contract annuitizes, a portion of principal is included in the annuity payout. The principal portion is not subject to tax.13 For federal income tax purposes, tax-free income assumes, among other things: (1) withdrawals do not exceed tax basis (generally, premiums paid less prior withdrawals); (2) policy remains in force until death (any outstanding policy debt at time of lapse or surrender that exceeds the tax basis will be subject to tax); (3) withdrawals taken during the first 15 policy years do not cause, occur at the time of, or during the two years prior to, any reduction in benefits; and (4) the policy does not become a modified endowment contract. See IRC §§ 72, 7702(f)(7)(B), 7702A. Any policy withdrawals, loans and loan interest will reduce policy values and may reduce benefits.14 For federal income tax purposes, life insurance death benefits generally pay income tax-free to beneficiaries pursuant to IRC Sec. 101(a)(1). In certain situations, however, life insurance death benefits may be partially or wholly taxable. Situations include but are not limited to: the transfer of a life insurance policy for valuable consideration unless the transfer qualifies for an exception under IRC. Sec. 101(a)(2) (i.e., the "transfer-for-value rule"), arrangements that lack an insurable interest based on state law, and an employer-owned policy unless the policy qualifies for an exception under IRC Sec. 101(i).

Cash value life insurance is an important addition for wealthy individuals who have already contributed the maximum amount to other retirement accounts, or who don’t qualify for certain types of accounts (like Roth IRAs) because their income is too high.

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The tax savings continue when you want to take the money out. At retirement, you can take loans or withdrawals from the policy which are generally tax-free4. Further, your distributions don’t contribute to the income thresholds that trigger taxation of Social Security benefits. This favorable tax treatment is hard to find in any other asset type.

4 Take Control of a More Flexible Future

Diversify to Help Reduce Tax RiskAs the baby boom generation retires, overall income tax receipts are likely to decrease. How will the government make up the shortfall to fund programs like Social Security? While we don’t know for sure, it’s entirely possible that the tax code may be changed in response to changing demographic realities. This could mean that tax rates may increase, assets which currently provide tax-deferred growth may be limited, or entitlement benefits may be reduced.

These potential changes contribute to tax risk. Because we can’t predict the future, it’s best to include in your planning a variety of different asset types, with different tax treatments, from the three distinct asset categories. By diversifying in this way, you may be able to reduce the negative consequences of a possible change to the tax code on your overall portfolio.


Cash value life insurance isn’t something that most people talk about, but for many affluent individuals, it can be overlooked as one of the best ways to help supplement traditional retirement plans. It can help you have the tax advantages and flexibility you want as you create a comprehensive plan for your family’s future.15 $19,500 is the maximum contribution in 2020.16 As of 2020, a $6,500 catch-up is available for those age 50 and older.17 Assuming 0% return during retirement.18 Assumes a 35% tax rate.

We’ve discussed how traditional retirement plans like 401 (k) plans and IRAs have contribution limitations that are fine for most people, but don’t allow high-income-earners the ability to save enough so they can continue their affluent lifestyle in retirement. Let’s look at an example that shows how these limits can negatively impact you.

Let’s say that you are 45 and started saving for retirement at age 35 by contributing $10,000 per year to your 401(k). You are now fully funding your 401(k) with the maximum contribution of $19,50015. Let’s assume that 401(k) contribution limits are adjusted upwards each year by 1%, and that you start fully funding the catch-up amount of $6,50016, also adjust upward by 1% each year, at age 50. Let’s say that your investment returns in the account are 6%, compounded annually. After 30 years, at age 65, you would have contributed over $665,000 and your account would be worth about $1.56 million.

Medical science is increasing our lifespans, so let’s assume that you live for 30 years in retirement. $1.56 million would allow you to withdraw about $52,000 per year from your 401(k)17. You are likely earning much more than that now, and will be earning even more by the time you retire. Plus, that amount is fully taxable upon withdrawal at your regular tax rate, which means you might only have an after-tax retirement income stream from your 401(k) of about $34,00018. Is this enough to fund the retirement lifestyle you dream of?

For some affluent individuals, the answer may be no. Of course, you might have other sources of retirement income like savings, Social Security, stocks, and real estate, but earnings from those vehicles are also fully taxable. We’ve learned that Roth IRAs are tax advantaged, but most affluent individuals can’t participate due to the income limits. If you want to keep more of your money for retirement, you should review all of the available options.

Cash value life insurance can also provide the flexibility to fund the policy based on your financial planning needs and access distributions before you retire. So, if you have financial obligations before age 59½ (the age you must be to withdraw from traditional retirement plans without penalty), you have the opportunity to access policy distributions. Or, you can leave the money for potential future accumulation– there is no forced distribution at age 72 as in qualified plans– to use when you see fit or leave to your designated beneficiaries. This is in addition to the safeguard for your loved ones who you have designated as beneficiaries provided by the tax-free death benefit.

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5 Conclusion

Pacific Life Insurance Company is licensed to issue insurance products in all states except New York. Product availability and features may vary by state. Insurance products and their guarantees, including optional benefits and any crediting rates, are backed by the financial strength and claims-paying ability of the issuing insurance company. Look to the strength of the life insurance company with regard to such guarantees as these guarantees are not backed by the broker-dealer, insurance agency, or their affiliates from which products are purchased. Neither these entities nor their representatives make any representation or assurance regarding the claims-paying ability of the life insurance company. Pacific Life Insurance Company is located at 700 Newport Center Drive, Newport Beach, CA.

This material is not intended to be used, nor can it be used by any taxpayer, for the purpose of avoiding U.S. federal, state or local tax penalties. This material is written to support the promotion or marketing of the transaction(s) or matter(s) addressed by this material. Pacific Life, its affiliates, their dis-tributors, respective representatives and life insurance producers do not provide tax, accounting or legal advice. Any taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor or attorney.

Pacific Life is a product provider. It is not a fiduciary and therefore does not give advice or make recommendations regarding insurance or investment products.

Life insurance is subject to underwriting and approval of the application and will incur monthly policy charges

Copyright 2020 © Pacific Life Insurance Company


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retirement tax strategies - highnetworthlife · income tax-free . distributions at death. 3 how...

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