Wednesday, May 22, 2024
Home Authors Posts by Brian Manderscheid

Brian Manderscheid

4 POSTS 0 COMMENTS
Brian is the vice president of Case Design at LifePro Financial. He works with over 1,500 financial professionals designing advanced case illustrations that are built for longevity and are always in the best interest of the client. With a specialty in advanced markets and wealth building, he analyzes the needs and goals of individuals and families and provides easy-to-understand, vibrant illustrations of where they currently are versus where they can be if solutions are implemented correctly. Manderscheid can be reached at LifePro Financial Services, Inc., 11512 El Camino Real, Suite 100, San Diego, CA 92130. Telephone: 888-543-3776, x3269. Email: Brian@lifepro.com.

Do Not Buy(Or Offer) An Indexed Universal Life Until You Read This

In 2022 everything went perfectly wrong for investors. With inflation running at 40-year highs and the Fed raising interest rates at its fastest pace ever, the S&P 500 lost almost 20 percent, which was the worst performance since 2008 when it was down roughly 38 percent. Historically, bonds perform inversely to the stock market which helps absorb stock market losses in down years within a diversified portfolio. However, even intermediate-term Treasury Bonds, long considered a safe haven, were down double digits at -10.6 percent. This was the biggest decline on record dating back to 1926. This prompted articles and debates on whether the long standing 60/40 portfolio was dead or if it is still viable.

While many investors suffered one of the worst loss years in recent memory, indexed universal life sales set a new record in 2022 with a total of $2.7 billion in sales, up 10.9 percent from the previous year. The influx of sales could be attributed to many factors. For instance, investors and retirement savers may be looking for lower risk vehicles to build and distribute wealth. Or they may gravitate towards the potential tax savings IUL provides on growth, access, and transfer. Maybe it’s due to the constant 24/7 marketing through social media channels. Nonetheless, IUL sales have continued their upward climb over the years and are no longer a “fad product” in the life insurance marketplace.

When I obtained my life insurance license in 2006 there were mostly only off brand carriers offering IUL with the big players stating they would never get involved. Since then, most of those carriers, including just about all the big names excluding a few career shops, now offer IUL as part of their product portfolio. So, what changed about IUL sales between the “wild, wild west” days of 2006 and where we are now? Well, I vividly remember IUL illustrations with 10 percent+ illustrated rates and variable loan spreads at almost five percent with some carriers. With these assumptions you can make an inferior product not only illustrate well but look better on paper than just about any financial vehicle out there. Luckily for all parties involved, this is not the case anymore.

Since then, there have been three rounds of AG-49 attempting to curb illustration abuses and mischievous sales practices. But there is always room to grow, and we can still improve how we provide the proper information to the consumer so they can make an educated decision on if using an IUL to supplement retirement is beneficial for them. The purpose of this article is to examine the issues surrounding the use of an IUL as a retirement supplement, what alternatives are available, and if/when IUL should be considered.

Right Vehicle, Wrong Fit
When coaching clients and advisors, the first question I ask when considering an IUL is, “What is the life insurance need?” The industry focuses so heavily on building and accumulating cash value, while often losing sight of the fact that an IUL is a life insurance product at its core. Clients looking at an IUL policy as a retirement supplement must have some basic need for life insurance first. This could be protecting income while working, debt or mortgage protection, or estate planning.

Far too many times I have seen advisors pitch IUL as an alternative to a 401k to clients who are not married, do not have kids, or do not own a home. I have also seen IUL policies put in force for clients who are severely health rated, which adds a significant amount of higher expenses to the policy and makes it much less suitable to use as a retirement supplement. Additionally, IUL policy expenses are front loaded, making it a poor option for older clients looking for income in a handful of years. Unfortunately, these advisors also fail to mention other tax-free options that may be a better fit, some of which I will expand upon later.

IUL should instead be offered to clients who are healthy, have higher income/net worth, have a need for life insurance, can fund premiums out of cash/bonds or cash flow for a minimum of five, preferably 10, years and have a longer time horizon.

Poor Design, Front Loaded Expenses
Assuming the client has the life insurance need, the next step is to ensure the IUL is structured correctly. Far too many times I see advisors “target fund” accumulation IULs to increase their commission at the detriment of their client. You see, the front loaded “per thousand expenses” and surrender charges are based on the initial base death benefit purchased which, in turn, calculates the target premium (or commission). When using IUL as a retirement supplement it is imperative to structure the policy at maximum efficiency. This entails designing the IUL with the least amount of life insurance the IRS will allow, funding right up to the IRC guidelines, and managing face option switches or reductions when allowable. Failure to do so can make the IUL one of the worst performing vehicles in a client’s retirement plan.

Designing an IUL at maximum efficiency does not give it an automatic pass as a viable option for a client to consider. Policy expenses from carrier to carrier vary wildly, with some carriers offering lower expenses while others are significantly higher. To demonstrate this, I ran illustrations through two different insurance companies offering accumulation IUL with the same client inputs. For this example, I used a 45-year-old male, preferred non-tobacco health, $50,000 annual premiums for 10 years, minimum increasing death benefit, switch to level in year 11 with a reduction to the minimum face amount.

Carrier A had cumulative expenses through age 85 of $125,028.

Carrier B had cumulative expenses through age 85 of $582,820, over four times higher internal expenses for the same exact scenario.

While Carrier B did have other features that Carrier A did not have, the fact remains if the underlying index does not perform as illustrated the carrier with the higher fee drag loses.

The Consolidated Appropriations Act of 2021 did provide some relief to IUL expenses by reducing the minimum IRS death benefit required per the level of premium funding. Nonetheless, IUL fees in general are front loaded with both low cost and higher cost carriers. Due to these front-loaded expenses, an IUL purchaser may not even break even on a surrender value (walk away) basis until after policy year seven or longer, even with a maximum efficient design and lower expense IUL.

IUL Swiss Army Knife, No Alternatives Given
In addition to the IUL design itself, it is essential the IUL is built within a comprehensive, holistic financial plan instead of looking at the IUL in a vacuum. Recently I have watched far too many cringy IUL pitches on TikTok or YouTube. These “internet famous” social media advisors seem to focus less on reliable and accurate content but more on sensationalism, views, and likes. I recently watched an advisor call an IUL policy a “501k” in a blatant attempt to misrepresent the product and make it sound like a government approved retirement plan.

Wild claims I’ve seen include: IUL policies will average double-digit returns without any loss or risk; IULs are far better than your 401k, even if you’re getting a match; IULs were previously secrets that only the wealthy were able to obtain but are now available to everyday folks like you and I; IULs will easily beat the stock market in the long run; and, ditch the old “never put your eggs in one basket” approach and instead put all your eggs in an IUL. The list unfortunately goes on.

The commonality in all these compliance departments’ nightmare sales pitches is the sentiment that the IUL is the “magic pill” that will take you from not having money to a wealthy multimillionaire retired on a yacht that is anchored on your own private island. But an IUL is not a get-rich-quick scheme and should not be portrayed as such. Also, IUL should never be viewed as an “instead of” vehicle. It should be correctly viewed as an “in addition to” vehicle.

Clients seeking tax diversification from taxable and tax-deferred vehicles should instead look at all the tax-free options available to them. Rather than putting all their eggs in an IUL, clients should instead consider Roth IRAs, Backdoor Roth IRAs, Roth 401ks, Roth IRA conversions, and an IUL for the right situation.

For example, if a married couple is younger than 50 and under the Roth IRA income phase out limit, they can contribute a total of $13,000 per year to Roth IRAs. Assuming both spouses also have Roth 401ks at their employers, they can contribute another $45,000 between the two. That is $58,000 annually this hypothetical couple can stock away into tax-free vehicles. Additionally, they may have a down income year for any given reason, which could open the opportunity for Roth IRA conversions if they have enough cash or cash flow to pay the taxes.

For higher income or net worth clients who have maxed out the above tax-free sources, the IUL provides that “next best” alternative for tax-free planning. Of course, assuming the IUL is set up with a highly rated carrier who has a strong track record of renewal rate integrity, done so for the right person, and designed correctly with a lower expense carrier.

Lastly, something we have not yet touched is the idea of “under promise and over deliver.” The current NAIC illustration model projects IUL values and loan arbitrage with constant and level returns. The reality is clients will get zero percent returns in bad years, causing their cash value to go backwards if they do not pay premiums. Or they may get potentially double-digit returns in good years. And, of course, everything in between.

Rather than illustrating the maximum client benefits that the insurance carrier software can provide, we instead recommend dialing down the assumptions. This could be through reducing the illustrated rate, reducing the illustrated income, or a combination of the two. While this may make your IUL illustration less competitive when compared to other advisor run projections, remember it is not about the illustration! Instead, it is more about creating realistic expectations with the potential to exceed them in the long run. While we can’t guarantee performance, one thing I can guarantee is you will actually make more sales, have more satisfied clients, and get more referrals if you under promise and over deliver.

Summary
With the rockiness we have seen in the stock market, the potential for an upcoming recession, the national debt crisis, and the Tax Cuts and Jobs Act sunsetting in 2026, IUL is positioned well for a continued rise in sales. My word of caution, however, is to make sure we continue to build the IUL industry the right way. This involves using IUL the right way for the right person. That includes selecting an appropriate IUL carrier emphasizing actual client performance and policy expenses, utilizing IUL as a part of a complete and holistic financial plan involving other tax-free vehicles, and providing realistic expectations and a clear explanation of benefits.


This material is intended for educational purposes only and is not intended to serve as the basis for any purchasing decision. Premium rates vary by a number of factors, including carrier, product, client health and age, and a number of other factors. Remember to consider your client’s individual circumstances and objectives when discussing their specific situation. Guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company.

Investment advisory and financial planning services offered through LifePro Asset Management, an SEC Registered Investment Advisor. Registration does not imply a certain level of skill or training. Investments involve risk.

Three Potential Discounts On Strategic Roth IRA Conversions

As clients prepare to meet with their financial advisors on planning strategies for the new year, this is the perfect opportunity to discuss how to potentially reduce their future tax obligations with a concept called, Strategic Roth IRA conversions. Over the past year we witnessed the National debt surpass $31 trillion dollars with record government spending and deficits. Not only has our nation’s debt gone up substantially, so have interest rates which compounds the problem. With no end in sight in reckless government spending, or a chance of a balanced budget, the tax risk your clients face will likely get worse not better. Fortunately, we can have a retirement tax escape hatch which your clients can utilize to avoid a ticking tax time bomb on their retirement accounts.

It’s no secret that, given the choice, your clients would rather have tax free growth, distribution and transfer than taxable benefits at potentially higher tax rates. Everyone wants a Roth IRA conversion, but simultaneously no one wants to pay the upfront taxes. What if you could provide your clients up to three discounts on Strategic Roth IRA conversion taxes? If structured correctly, your clients can use this strategy to enjoy tax-free income in retirement, leave a tax-free legacy to their kids and grandchildren while also minimizing their upfront Roth IRA conversion tax obligations.

The three potential discounts are the 1) tax rate discount; 2) market value discount; and, lastly, 3) tax base discount. First, let’s talk about the tax rate discount. With the Tax Cuts and Jobs Act sunsetting in 2026, we’re in a unique situation where we know that tax rates will be increasing in 2026 for most clients. The way to paint this picture is by reminding them that they are going to go to bed December 31st, 2025, on New Year’s Eve and wake up the next morning on New Year’s Day, January 1st, 2026, owing more taxes.

Not only will most of your clients face higher income tax rates in 2026, but it also means that they’re going to have a lower standard deduction. Further, the child tax credit is also being reduced as well as changes in AMT and capital gains. By converting their IRA or 401k over the next three tax years, they’re getting a discounted rate compared to if they wait until 2026 and beyond to do those same conversions.

The other big issue on top of your client’s mind is the current rampant inflation. While stubbornly high inflation has been a thorn in our sides, it does have a surprising benefit: Increased top end marginal tax brackets. In 2023, the tax brackets (not rates) are all being bumped up on a dollar basis. For example, the top end of the 24 percent tax bracket for married filing jointly is going up by about $24,000, essentially allowing your clients to convert more and still stay in the same low tax bracket.

Let’s move on to the market value discount. Unfortunately this year has not been the greatest for both stock and bond returns, and our account balances, unfortunately, have suffered. For example, if we look at the S&P 500 it’s down about 24 percent as of the end of Q3 2022. Not just the equity markets, but the U.S. Aggregate Bond Index was also down almost 15 percent over that same timeframe! Nobody likes losing money, but we can actually use this pullback in the stock market and bond market as a potential opportunity. Let’s say, for example, the balance of your client’s IRA was at $400,000 at the beginning of the year, and they lost 25 percent, bringing down their account balance to $300,000. What that means is they can convert a lower value and therefore pay lower taxes. In addition, once the stock market eventually rebounds, which historically it does, all those future gains will be tax-free. In contrast, if they wait until the market does potentially rebound, they are going to be paying taxes on a higher amount. The problem with this is that we typically don’t convert an entire account balance in one tax year as it can push your clients into higher marginal rates. The third strategy I discuss will help eliminate or reduce that potential increase altogether.

Lastly, let’s talk about the third discount, which is the tax base discount. I mentioned earlier that the potential downfall or obstacle with doing strategic Roth IRA conversions is that we don’t typically convert an entire balance in one tax year to avoid bumping a client into a higher tax bracket. Generally we convert over a period of time, typically the next three tax years prior to the 2026 Tax Cuts and Jobs Act sunset or up to a specific tax rate or income threshold. The problem is, what happens if the market rebounds over those next three years or more? Your clients would have to pay taxes on higher balances each year.

What we can do is lock in today’s tax base using a five-year point-to-point index with a lock feature. With this strategy, your client’s account value doesn’t grow until the end of the fifth year (unless locked during the five-year index segment). Normally that may not be the best strategy, but this works out perfectly for Strategic Roth IRA conversions. It allows us to lock in today’s tax base, avoid any future stock market losses and convert over time without having any increase on their account value. Once we convert all of the IRA at the end of the third or fifth year, all of the potential indexed gains would be tax-free.

Let’s say your client has a $300,000 account balance growing at a hypothetical 10 percent rate. If the market rebounds and they don’t use this discount, they would convert $100,000 today, and kick the remaining conversions into tax years 2024 and 2025 at a potentially higher account value. What this means is they would convert $100,000 in 2023, $110,000 in 2024, and $121,000 in 2025, which comes out to a total of $331,000 over the next three tax years. If the market rebounds, your clients will pay more in taxes by converting over time. However, if they use a five-year index, which doesn’t grow until the end of the fifth year (unless locked), they can convert $100,000 over the next 3 tax years with a total amount converted of $300,000. If they’re in a 24 percent tax bracket, they are saving about $7,500 in taxes using the strategy. At the end of the fifth year all the potential index gains will be tax-free.

To summarize, your clients want to pay less taxes in the future but are also looking for creative strategies to pay less taxes today. With the nation’s debt at $31 trillion and growing, the Strategic Roth IRA conversion strategy is something that we are really passionate about. This is a huge issue that is likely to affect the people who pay the majority of taxes, who are high-income-earning families. There is an incredible opportunity here to take all these three potential discounts into your clients favor and provide tax-free benefits for their future.

For help getting this message out as well as over 250+ additional client friendly concepts please visit: https://www.lifepro.com/blog?category=Money%20Script%20Monday.

One Of The Best IULs You’ve Probably Never Heard Of

0

With all of the recent government tax and spending proposals, some of which may be signed into law in some form or another, the concept of tax advantaged growth and supplemental tax-free retirement income from a properly structured indexed universal life is certainly continuing to gain steam. Of course, coming out of a major pandemic, prospects and clients also can better see the value of owning life insurance. As a 15-year veteran in the indexed universal life space I can tell you that today there is no shortage of IUL products in our industry. Each tend to fit inside a particular niche, whether that is accumulation-focused, death benefit protection or even living benefits such as chronic and critical illness. Out of the roughly three dozen indexed universal life products, there are a handful, maybe just two, of top tier IUL’s that excel in the cash value accumulation space.

However, you can have the best IUL in the marketplace, and if it’s not structured within the best interests of the client with the minimum amount of life insurance that the IRS will allow, funding right up to the maximum Internal Revenue Code guidelines, it could actually be a poor addition to a client’s overall financial plan. It’s important advisors work with a qualified independent marketing organization who can shop around insurance companies to find the best product for a client’s situation, are leaders in the IUL space, and can set these up correctly.

One of the best, top-tier, accumulation focused IUL policies is actually one you may have never heard about. The reason being it’s a proprietary product only available to a select group of high-quality organizations and their respective advisors.

First, to backtrack to 2015, and again to 2020, there were two different regulations that were put in place to help minimize the illustrated values and loan proceeds of IULs. This was an attempt to get rid of some of the abusive sales practices in our industry, all of which were great steps for prospects and consumers alike. However, some insurance carriers reacted by making this great product more confusing, introducing various bonus options (some guaranteed while others being non-guaranteed) and adding significantly higher policy costs to an already somewhat expensive product.

Really their goal was to provide the best looking illustration and ledger to the prospect in hopes of winning the “illustration war.” The company I want to focus on today did things the exact opposite. Rather than focusing on the best looking illustration, they took the path of focusing on the best long term consumer value. To do this they’re not relying upon bonuses to provide the value. Instead they’re focusing on a simple design, low policy costs, high uncapped performance, loan flexibility and a proven history of high renewal rates.

This insurance company has one of the lowest policy costs in the industry, and to highlight that, the premium load is only 5.5 percent. The reason I point this out specifically is that premium loads have increased substantially with some of these new generation IUL products. Those premium loads are used to cover state premium taxes, the cost of bonus features, even profitability for the insurance company and of course advisor commissions.

This company has also updated their IUL product with the updated 7702 guidelines. January 1, 2021, the IRS updated the 7702 guidelines which dictate the level of life insurance that needs to exist in order to receive all of the tax benefits permanent life insurance provides. Resultantly, insurance companies were able to update their products and basically reduce the amount of life insurance that must exist for the dollar of premium funding. The benefit for this IUL is they’ve already updated it with the new 7702 guidelines which further reduces the life insurance cost structure. Additionally, they’re a highly rated insurance company. They have a 96 Comdex. Comdex is a 1 to 100 score, and 96 is one of the top ratings for a life insurance company offering an indexed universal life.

Let’s next talk about the fact that it’s a proprietary product with proven performance. Now, to give you an analogy, there are other low cost IULs in the industry, but think of them more like a Prius. You’re going to have the efficiency and high miles per gallon, but you are not going to have the horsepower or performance. This IUL not only has the efficiency in the low policy expenses, but it also has the performance upside. So think of this IUL more like a Tesla, where you have the efficiency of the electric engine but you also have a high amount of horsepower.

To do this, this product has three different uncapped index strategies all with participation rates greater than 100 percent. Let’s say the underlying index provided a 10 percent return and your participation rate was 125 percent. Your client would receive a 12.5 percent rate of return with no cap or upside limit. They also have three different index crediting segments: A one-year, a two-year, and a three-year, all with impressive 30-year lookback returns. As we know, past performance doesn’t predict any future results. While the averages look great, they look at past index data and current participation rates. We don’t know what the next 30 years of index data will look like and what participation rates will be. The low interest rate environment may continue to cause a drag on the insurance companies’ general portfolio yields causing participation rate pressure.

30 Year Average: One-year segment 7.55 percent, two-year 8.18 percent, and the three-year 10.63 percent.

Again, all very strong returns, but I’d take that with sort of a grain of salt considering we don’t know what the next 30 years will look like. The way these indexed allocations are structured is that the insurance company can provide higher cap and participation rates based on the cost of the options. These options and derivatives are based on the volatility of the underlying index and the time length of the index segment. Longer indexed segments essentially allow the insurance company or investment bank to offer greater cap or participation rates.

However, there is some risk with longer-term segments. Let’s say you have two really good years where the underlying benchmark is having a solid run. But a bad third year comes along that may potentially wipe out all your gains for the entire three-year segment. One way we mitigate against that is a very diversified approach. We recommend allocating a third into each of these indexed segments. Not only are we diversifying allocations, but we are also diversifying time. One key differentiator of this IUL is that it provides partial index credits for three reasons: Monthly deductions, withdrawals and death. With most insurance companies, if your client dies halfway through the segment, their beneficiaries are not going to receive an index return. With this policy, let’s say you’re two years in on a three-year segment and your client passess away. Their beneficiaries will still receive proportionate credit for the time they were in that index segment. Again, not only are we recommending diversifying the indexed strategies, but we also have a feature in this IUL to help mitigate against some of the risk of longer-term segments.

Lastly, loan types and rates are crucially important for a top-tier accumulation IUL. The way these policies work is you’re not actually withdrawing money from your life insurance policy, you’re merely taking a loan from the insurance company with your life insurance cash value and death benefit as collateral. Additionally, the amount you borrow from the insurance company continues to earn index returns in the contract, which can be quite substantial. The way to win with an accumulation IUL policy is to have low borrowing costs from the insurance company and high upside on the index.

This insurance company has three different loan types. A fixed loan (net wash after 10 years), an indexed loan and a variable rate loan. The index loan has a contractually set guaranteed rate of 4.75 percent. No matter what happens with interest rates, the insurance company can never charge more than that stated rate in the contract. The variable loan works a little differently, as the rate is based on the Moody’s Corporate Bond Yield Average, which as of right now is historically extremely low.

You may ask yourself, what happens if interest rates increase with a variable rate loan? Well, that is going to increase the variable loan rate. However, there is a cap in this policy of one percent over and above the fixed rate, which is similar to a moving target. The fixed rate currently is 3.25 percent, so one percent above that creates a current 4.25 percent cap. The nice thing about this IUL is it allows for the ability to switch loan types once per year. Hypothetically if your variable rate loan starts to exceed 4.75 percent you can switch loan types to the index loan and lock in that 4.75 percent rate. The nice thing again is this insurance company gives you the flexibility to decide that.

To summarize, this proprietary IUL offers a simple, low cost design, high indexed upside performance and great loan options with plenty of flexibility. To top it off, it’s offered by a highly rated carrier that has plenty of experience in the IUL market place. Our high net worth and high-income earning clients are looking for solutions to mitigate current and future taxation. If you aren’t delivering this message, they will surely be hearing it from someone else.

How The New Tax Law Created The Perfect Storm For Roth Conversions And Indexed Universal Life

0

There are three things that are certain in life: Death, taxes and tax law changes.

In December of 2017 the Tax Cuts and Jobs Act (TCJA) was passed creating a limited window of opportunity to pay taxes now at possibly the lowest tax brackets of our lifetime. There were many significant changes to the individual income tax laws including reforms to itemized deductions and the alternative minimum tax, increased standard deductions and child tax credits, and lower marginal tax rates across all brackets. The intended results for the lower income tax rates for individuals and businesses was to spur economic growth and create new jobs. The unintended consequences may very likely be higher federal debt levels and higher future income tax rates-especially for higher income earners. As the law stands today the individual income tax reductions end December 31, 2025, and will sunset in 2026 to the pre-TCJA levels from 2017. This assumes of course another administration doesn’t impose legislation to repeal the TCJA and put in place a new set of tax laws. This would once again spur another round of tax resolution marketing from accountants in order to find clients that need their taxes done correctly and legally.

So what does this mean for us?
Specifically addressing lower tax rates, this may cause traditional retirement accounts such as 401(k)s and IRAs to become less favorable. This will automatically spur the need for tax-resolution-services as people will want to understand where they stand in terms of their tax accounts. The reason being that 401(k)s and IRAs are specifically designed to defer income for today’s tax dollars with hopes of withdrawing contributions and gains at a lower tax rate in retirement. With a lower tax rate today the implied benefits of upfront tax savings would be reduced. For example, let’s assume a married couple 50 or older earning $200,000 and contributing $20,000 towards a 401(k). This couple would have been in the 28 percent tax bracket pre-TCJA and a 24 percent tax bracket currently. The impact is that the “tax savings” on the 401(k) contributions would reduce from $5,600 to $4,800-which is more than a 14 percent reduction. Something critical to point out is that in both situations we really aren’t saving taxes, but instead merely deferring taxes to a future date with an unknown tax rate. Essentially we are kicking the can into an unknown future where tax rates may in fact be higher. If you want to find out more about the art of taxes, you might want to ask someone this like tax accountant NYC any questions you might have on taxes.

With the tax rate drop and uncertain future tax rates, Andy Friedman of the Washington Update believes retirees should plan for something called “tax volatility.” Andy, a former tax attorney and current keynote speaker, stated investors “should maintain liquidity in both taxable and tax-deferred accounts and in tax-free investments. That way they can withdraw funds from one or the other depending on whether it makes sense to pay taxes that year (and if so whether to pay at ordinary income or capital gains rates).” Friedman adds, “Preparing for tax volatility allows an investor to take advantage of tax changes, whichever way they might go.”
Andy Friedman’s comments echoed what we at LifePro have been saying for years. Due to future tax rate uncertainty, our clients should add “tax diversification” to their overall comprehensive retirement plan by making sure they have an adequate mix of dollars inside their taxable, tax deferred and tax free buckets. Make sure clients are properly diversified in various asset classes (stocks, bonds, real estate, annuities, life insurance, etc.). Why not take the added step to also diversify tax types? Financial experts across the country are making similar statements-the TCJA could mean vehicles like Roth IRAs, Roth 401(k)s and indexed universal life may be more appropriate for some investors.

What do industry experts anticipate?
Experts are saying the income tax deduction from a 401(k), or traditional IRA, provides less value in a low tax rate environment, particularly when the deferred income may be taxed at higher future tax rates. While we can’t be certain tax rates in the future will be higher, we can look at data from the best and brightest who believe we as a nation are on an unsustainable path with trillions of dollars in debt coupled with trillions in unfunded future liabilities.

Another popular keynote speaker, David Walker, former Comptroller General of the US and head of the GAO for a decade, stated government debt “is not just a financial issue. This is not just an economic issue. This an ethical and a moral issue. We are mortgaging the future of our kids and grandkids at record rates.” Walker, essentially the top accountant for the US Government, has intimate knowledge of our government’s spending, budget and debt. In fact, he once said “we are heading to a future where the U.S. Government will be forced to either cut spending by 60 percent or double federal tax rates.” Regardless of what the current or future administrations propose, they are all inheriting the same math problem in which there are limited solutions: Spend less, increases taxes, or some combination thereof.

What can we do as advisors?
First, we must educate our clients about the importance of tax diversification by making sure we are not neglecting the tax free bucket. We can start to fill up the tax free bucket either by converting existing IRA assets towards Roth, contributing to a Roth IRA or Roth 401(k), or funding an indexed universal life policy. There isn’t a clear one-size-fits-all plan and it depends on each client’s individual financial situation. Clients who are heavy in traditional IRAs and have adequate cash accounts to pay the tax bill may benefit the most from strategic Roth IRA conversions over the next seven years during the TCJA lower tax rate window. One popular strategy is to convert up to the room left in your current marginal bracket. For example, a married couple with a $50,000 AGI can convert almost $29,000 and stay within the 12 percent bracket without jumping up to the 22 percent bracket. For clients who haven’t yet accumulated a significant pre-tax retirement account balance, or have limited cash accounts but have the ability to redirect cash flow, may be better off contributing to a Roth IRA, Roth 401(k) or indexed universal life.

Of course there are income phase outs on a Roth IRA and contribution limits on both the Roth IRA and Roth 401(k). Indexed universal life combines the tax deferred growth and tax free access of cash value with an income tax free life insurance death benefit. Additionally, the cash value growth is not directly invested in the stock market. Instead the growth is based on the price change of an external index, such as the S&P 500, with a limiting factor such as a cap or participation rate. The trade off on the upside limit is a zero percent annual floor protecting the cash value from negative market performance.

As for funding indexed universal life we always want to make sure to buy the absolute minimum death benefit the IRS will allow and fund up to the Internal Revenue Code guidelines. By doing so we can minimize the mortality expenses, which in turn will maximize cash value growth potential. A common structure is to design the IUL policy with the minimum increasing death benefit with a seven year or greater funding period, paying up to the maximum premium limit and switch the death benefit to level once the client is permanently done funding. We call this a “long pay” design as the client has the ability to fund premiums for a longer period of time. We generally use a long pay design for cash flow funded cases where we want the flexibility of being able to choose how long we want to fund. A second common structure is to design the IUL policy with the minimum level death benefit and fund up to the seven-pay premium until we fill up the Guideline Single Premium (GSP), which generally takes about five years depending on the age, gender and risk of the insured. Additionally, with this strategy we can reduce the death benefit down to the minimum cash value corridor after the cumulative Guideline Level Premium (GLP) crosses over the Guideline Single Premium (GSP). We can also use a “short pay” design since our goal is to fund the policy as quickly as possible. We generally use a short pay design for asset funded cases where the client has existing assets and wants to fund those into an indexed universal life policy for the tax favored treatment and competitive returns while eliminating the downside market exposure.

What’s next?
While the TCJA has reduced individual income tax rates for the next seven years, we must look at the bigger picture. Just like a client who is stuck in the repetitive debt cycle, we as a country must first come to terms with our current situation and then act decisively. As advisors we also share some of this burden. It is not just our job, but it should be our mission, to help educate our clients and prospects on the importance of tax volatility and tax diversification. Just like David Walker, we believe we have an ethical and moral obligation to share this information with as many people as possible in hopes that we can help lead them down the right path. More than ever our clients are looking for certainty, clarity and confidence in these uncertain times-which only you can provide.