401(k) Plans vs. EIUL

Should Your Clients Tax-Defer Money into Qualified Plans/IRAs
NO!  (read Part I of this series to find out why)

            Why income tax-defer into a 401(k) or IRA? 

            When you income tax-defer money, you are using the government’s money for a period of time to help increase your retirement nest egg. 

            If you have clients in the 35% tax bracket and asked them if they would like to put $1 to work in a tax-deferred account or 65 cents after-tax, what would they say? Of course, they would say $1.

            What’s the problem with income tax-deferring money?   You have to pay income taxes on ALL of the money when you remove it from a tax-deferred account.

            Let’s look at an example. Assume you have a 45-year-old client in the 35% income tax bracket who can tax-defer $15,000 a year each year for 21 years into a 401(k) plan.  Assume the money grew annually at 7% (gross) in mutual funds with a 1.2% annual mutual fund fee. Assume the client removed the money from the retirement plan in equal amounts from ages 66-85 where the account balance is ZERO after the last withdrawal.

            How much would the client have after-tax each year in retirement IF we assume he is in the 35% income tax bracket in retirement?

            $29,642 (his gross withdrawals are $45,604 a year)

            Income Tax Brackets. Most people think that our income tax brackets are going to be changing with the new president. Look at some of the past highest personal income tax brackets.  

            -1965-  70%
            -1980-  70%
            -1986-  50%

            It’s safe to say that we are at historic lows when it comes to our personal income tax brackets (and it’s not going to last much longer).

            What if we assume the example client will be in a higher tax-bracket in retirement?  The question then is how high will income tax be in 5-10-15-20+ years?   The answer is that no one knows.  Therefore, I’ve just created a spreadsheet of multiple tax brackets and how much would be left after taxes upon withdrawal in the previous example.

Income Tax Bracket in Retirement          Annual Amount withdrawn

                             40%                                            $27,362

                             45%                                            $25,082

                             50%                                            $22,802

                             60%                                            $18,241

                             70%                                            $13,681

*If you lived in California, you’d pay an additional 9.3% in personal income taxes on withdrawals.

            What’s the point?   Simply telling someone to income tax-defer money into a qualified retirement plan or IRA is not as simple as it sounds.  You need to discuss with your clients whether it makes sense to fund them; and, if not, what other alternatives are available.

            Stock Market Protection

           
            Aside from the potentially disastrous tax implications of funding qualified plans, because the vast majority of clients put their 401(k)/IRA money into mutual funds, they have no stock- market protection. How’s that working out for most of the American public over the last 18+ months?  Not too well.

            Assume you have a client who had accumulated $250,000 in a tax-deferred 401(k) plan at the high point of 2007 and is getting close to retirement.  What would have been the account balance in 2008 after the market declined by approximately 59%?  $102,500.

Is building wealth using income tax-deferred 401(k) plans/IRAs a good idea?

            The answer is that it almost always makes sense to fund a 401(k) plan if an employer will match the employee’s contribution.

            What if the example client took his money home (instead of tax-deferring it into a qualified plan), paid taxes on it in the 35% bracket, and invested into mutual funds with a 1.2% annual expense and a 20% blended capital gains/dividend tax rate on the gains?  How much could be removed from that account every year from ages 66-85?  $26,032

            How much could the client receive after-tax from his 401(k) plan?   $29,642

            Hmm….that’s odd. Then why does the title of this newsletter indicate that it is not a good idea to fund a tax-deferred qualified plan?

            Because there are other alternative places a client can grow wealth and receive:

            -more after-tax money in retirement  

            -protection from stock market risks

            -protection for the family if the bread winner dies early

            -a free long-term care benefit

            What wealth-building tool has the above characteristics?  Revolutionary Life Insurance, and I’ll give you the numbers and a further explanation in next week’s newsletter.

            If you wonder how much could be removed from Revolutionary Life after-tax using an apples to apples comparison, the numer is $35,545 a year tax free (and the client had downside protection, a FREE LTC benefit, and a nice death benefit). 

            Calculating the numbers (New sales software)

            If you would like to communicate the value of usign cash value life insurance as a wealth building tool and show clients the real math comparing EIUL to using a tax-deferred 401(k) plan, plesae click here to learn more about ECA's proprietary illustration software.  If you are not using this software to communicate the value of EIUL, you are missing out on a terrific opportunity to grow your business and earn more money.