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Home / Insurance / Are you going to cancel your IRA to buy life insurance? • Insurance Pro Blog

Are you going to cancel your IRA to buy life insurance? • Insurance Pro Blog

There are life insurance agents, motivated by various marketing organizations, who tell people that their taxes are increasing. Far up. Mostly because the social insurance is bankrupt. They even have a super cool and incredibly authoritative person to refer to. David Walker, the former US inspector … he has been complaining about the SSA for several years. In fact, he predicted all sorts of doomsday scenarios … most had timelines already behind us. But hey, no worries, SSA is still bankrupt.

Now, if you understand US tax law, you may know that Social Security benefits are funded through taxes collected under the Federal Insurance Contributions Act (FICA). These are payroll taxes. They are deducted from salaries that you earn, or valued against business income that you generate. They fund programs like Social Security and Medicare. These taxes are different from the federal income taxes you pay ̵

1; most of these dollars go to defense spending.

But they are different, as well as really different. Technically, the United States collects these taxes for its intended purposes and used them for its intended purposes.

Now, current forecasts suggest that social security will be completed without the surplus created by tax revenues by 2034. And it is this discussion of the final end of the FICA surplus that serves as the key argument behind the soon-to-be massive tax increase facing Americans.

But it’s something else …

Historically low taxes?

Taxes are probably low. Which really lay right now.

Here is a frequently referenced chart that proves the point:

Archive: Historical marginal tax rate for highest and lowest income earners.jpg

If you look at this chart, it really does seem that our current tax levels are significantly lower than they once were.

But there is a problem with this argument. The information shows the marginal tax rate in nominal terms without context for the complexities of the tax law that have existed throughout history. We see a fairly rapid decline throughout the 1980s. This was a major Reagan initiative. But what we do not often see through these data was the catastrophic change in tax legislation that took place at the same time. The Reagan administration’s tax laws did not reduce taxes as much as they simplified and reduced marginal income tax rates. This was really beneficial for people whose incomes were falling in stratospheric levels at that time. But the overall move was ultimately neutral when it came to collected absolute tax money. Marginal rates fell, but at the same time many deductions and credits ceased.

So does this chart prove that we are well below average in terms of rates and are ready for a big increase? No, not even at a distance, and anyone who claims it is either deplorably misinformed or deliberately trying to mislead you.

But social insurance is a problem, right? One that can only be fixed with tax increases? That’s probably true.

However, these tax increases will not affect pensioners. They do not pay FICA, unless they have a job in retirement. Your savings will not result in a FICA tax, not without a massive revision of US tax law.

But let’s ignore for a minute the crazy claims made by some insurance marketers and their agents about rising taxes, and let’s focus for a moment on the profitability of using life insurance by raiding your qualified savings (ie 401 (k) or IRA) and instead put it in the life insurance.

Liquidate your IRA case study

Let’s assume that a 40-year-old man with $ 500,000 in an IRA he rolled from a 401 (k) with his former employer. Johnny McMorning, a life insurance agent, suggests that he liquidate the IRA for the next 10 years and use that money to finance a life insurance policy. Johnny claims that this will save countless amounts of taxes, especially after the financial calculation that will be made due to the insolvency of social security.

McMorning points out that because life insurance builds cash value, it will be a primary source of tax-free income upon retirement that will completely ignore any downward tax increases.

Looking at some numbers:

Stick to the plan and make $ 20,000 contributions to the new 401 (k), take an income of 5% withdrawal against the IRA balance from retirement to create an annual income of $ 150,488 after tax

Liquidate the IRA according to McMorning’s recommendations and redirect planned contributions to a life insurance policy. Since we can not recommend anyone to put all their money on life insurance, we split the planned annual contributions of $ 20,000 between the life insurance and an unqualified general broker account. Total annual income after tax using the entire life insurance and a withdrawal amount of 5% against the broker account is $132,675 after tax.

Ignore McMorning’s advice, keep $ 500,000 in the IRA, and start a new policy that finances it with the planned contributions that would have gone into a new 401 (k). Withdraw 5% of your IRA balance and use your lifetime policy to generate retirement income. The total annual income after tax is $ 153,996 after tax.

But keep in mind that these numbers are numbers after tax with current tax rates. One of the biggest arguments for waiving your IRA in favor of life insurance is the fact that we have no idea what tax rates will be in the future. Some like to ask the question “would you borrow money without knowing the terms of the loan?”

To get a higher net income with the liquidate IRA plan, taxes on this individual must increase from 26% today to 35% during retirement. This is a big increase for someone whose income will fall in the middle of the tax schedule. And remember, we do not fund social security with federal income tax, so we need some other major changes in US federal budgeting to necessitate such an increase in income tax.

The point that we do not know what future tax rates will be is indisputable. It is also wise to note this and consider a possible change in strategy with regard to how we proceed to save for the future from now on. But we can make estimates of what future tax rates may be and then make reasonable estimates of the risks of keeping taxable pension accounts. From the example above, I would argue that the chances of an increase from 26% to 35% are quite low.

Paying taxes is not the worst case scenario

I know I’ll lose some of you with this episode, and that’s fine. You can overreact to an emotional subject and hurt yourself if you want to. But paying taxes is not the end of the world. Yes, we would like to prepare for a situation where fewer dollars are eroded by taxes. But if the dice have already been rolled, it is now a challenge to maximize what we have with what we have done.

Paying taxes is not fun. But there is really nothing that is worth avoiding at any cost. In the example above, an attempt will end up losing nearly $ 18,000 in annual income. It’s a lot of money to give up just to say you did not have to pay taxes.

Inflating taxes and their impact on pension savings is one of the last bastions that some life insurance agents / marketers feel they need to make life insurance mandatory against public investment. I personally do not think this is true, but many of them do. Much like our recent conversation about exaggerating effective tax rates to boost internal returns, this is also an attempt to expand what life insurance can produce. It is full of technical half-truths that disguise themselves as the whole picture.

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