How To Maximize Your Tax Free Retirement Income

A properly structured whole life insurance policy is one of the best tools you can use to grow your retirement savings in a safe manner and reduce your tax burden. When I say a properly structured policy, I’m not talking about a typical whole life insurance policy. I’m talking about a policy issued by a mutual insurance company that has two very specific riders. These riders are designed to maximize the amount of premium that goes towards growing your cash value. With proper design and planning, you can earn a return on cash in excess of 5% annually and you will never have to pay a dime in taxes on the gain.

Goal: Build Cash Value Where the Gains Are Tax Free.

Step 1 – Find a Mutual Insurance Company. There are two types of insurance companies, mutual companies and stock companies. A stock insurance company is owned by the shareholders and profits are distributed to the shareholders. A mutual insurance company is owned completely by its policyholders. Profits at a mutual insurance company are returned to the policy owners. The profits are returned either as a dividend or a reduction in future premiums. The amount of dividend a policyholder receives depends on the amount of cash value in his or her policy.

A few examples of dividend-paying mutual insurance companies include Penn Mutual, New York Life, Northwestern Mutual, Guardian Life, Lafayette Life, KSKJ Life, Mass Mutual, Ohio National, and OneAmerica, to name just a few.

Step 2 – Find an agent that knows how to design a high cash value whole life policy. This is the easy part. That’s us. We are an independent brokerage that compares rates and cash value accumulation across multiple mutual insurance companies. Fill out the quote form if you would like more information.

Step 3 – Design the Policy. We will design the policy but it is important that you understand the concepts at a high level. With a traditional whole life policy, every time you make a premium payment your money is placed into two buckets. The first bucket goes to the insurance company. This is essentially the cost of your insurance. The second bucket is the cash value bucket. This is your money. You can access that money at any time in the form of a loan or a withdrawal. Or you can surrender the policy and receive the full cash value. The insurance company guarantees a certain rate of growth on the cash value. Every year the policy is in force, the cash value grows at this guaranteed rate. There is even a page in your policy that tells you exactly how much cash is in the policy after every year. The only way you won’t have access to the cash is if the company is insolvent.

You might be wondering what’s the problem with a regular old whole life policy? In some cases, a traditional whole policy works great. For example, if you wanted to cover the cost of your final expenses or to guarantee a certain death benefit for a family member. However, for tax-free retirement savings, a traditional whole life policy does not achieve an attractive rate of return.

Essential Riders – In order to increase the rate of return we need to add two riders to a traditional whole life plan. The first rider is a paid up additions rider and the second rider is an enhanced blended insurance rider. I’ll describe both riders in more detail. The important take away is that both of these riders increase the amount of money you can put in the cash value bucket while decreasing (on a relative basis) the amount of your premium that goes into the cost of insurance bucket.

  1. Paid Up Additions Rider (PUA)- A paid up additions rider allows you to add to your insurance policy by making a one-time payment. Here is how a PUA works: Say you wanted to buy a whole life insurance plan with a $100 death benefit. To buy this policy you could pay $1/year for the rest of your life, or you could make a one-time payment of $20 and be insured for $100 for the rest of your life. The nice thing about this single payment policy is that nearly all of the $20 is accessible as cash value immediately. With a PUA rider, every time you make a premium payment you are buying small, single payment whole life insurance policy.
  2. Enhanced Blended Insurance Rider (EBIR)- This rider allows you to purchase term insurance that renews annually. It increases the death benefit of the policy. However, its primary purpose, in this case, is to allow you to put more of your premium in the cash value bucket. The technical details of how you can overfund your policy using an EBIR are complicated. All we need to know is that an EBIR lets you put more money in the cash bucket without turning your policy into a Modified Endowment Contract or MEC.

When optimized to accumulate cash value for retirement, most plans will have between 65% and 75% of the premium go into the policy as paid up additions. The exact portion of your premium that is allocated to PUAs is dependent on your age, gender, and health rating. This PUA portion of your premium starts earning dividends immediately and is accessible to you at any time for any reason.

Avoid the MEC – With PUA and EBIR riders in place, the goal is to minimize the death benefit and maximize the cash value inside the policy. We want as much of our premium going into the cash value buck as possible. We must get the plan to be as close as possible to a MEC without turning in to a MEC. If a policy becomes a MEC we lose all the really awesome tax benefits the IRS gives to whole life insurance. The concept of a MEC came out of the Technical Corrections Act of 1988. The IRS wanted to limit the amount of money that could go into a life insurance contract and still qualify for favorable tax treatment. So when it comes to life insurance, the old days really were a better time.

Divided Option – As stated earlier, all the policies we recommend are participating whole life policies. That means they are issued by a mutual insurance company the policyholder participates in the profits of the company. These profits are distributed as dividends based on the cash value of your policy. You have three options on how you want to receive your dividend. Option 1 is to receive your dividend as a reduction of your premium payment. Option 2 is to receive your dividend in cash. Option 3 is to receive your dividend as a paid up addition to your policy. Option 3 is the best option for putting the power of compounding interest to work for you. It is what we recommend, especially in the early years of the policy.

Contact us if you have questions about how properly structured blended whole life insurance plans can provide you with a safe, flexible tax-free retirement.