Another IRA Rescue Strategy to Avoid
IRA Rescue using life insurance
The idea of using life insurance to “rescue” money from an IRA has been around for decades. It used to be a fun topic where agents could make a lot of money with clients who had estate tax problems and before the IRS killed springing cash value policies.
This concept seems to be back with a vengeance now, but it’s not an estate planning play─it’s one based off of income. It sounds so simple and alluring.
Agent: Do you think taxes are going to go up in the future?
Client: Yes.
Agent: Would you like me to show you how to rescue money from your tax-hostile IRA so it can grow tax free and come out tax free?
Client: Yes.
Number manipulation—when the client says yes, the agent pulls out a totally unrealistic illustration that does the following:
1) Shows taxable withdrawals from the IRA for 3 years.
2) Pours the entire withdrawal from the IRA into an IUL (Indexed Universal Life) policy as the premium.
3) Has the client in years 2-4 borrow money from the policy to pay the tax on the IRA withdrawal from the previous year.
4) Allows the money to grow and then shows the client magically being able to take out tons of money tax free from the policy in retirement.
It sounds great, right? We should all be selling three-pay policies with huge commissions.
It doesn’t work!—the problem is that the only way to make this strategy work on paper is to use totally unrealistic assumptions when running the life illustration.
Real-life example—I’ve had a handful of these come across my desk in the last few weeks, and I hear it’s being pitched quite a lot out there which is why I wanted to do this newsletter.
Client: 58-year old male, standard non-smoker with $1 million in an IRA. Use a 7.7% illustrated rate on the IUL with a 4.25% lending rate on the variable loan.
1) Take a $333,333 taxable distribution from an IRA and pay that as premium into an IUL policy each year for 3 years.
2) Take a $163,333 loan from the policy in years 2-4 to pay the taxes on the withdrawals.
(Side note: This is essentially a hyper-funding scenario which is a concept I warned readers about years ago.
3) Let the policy grow until age 65 at which time the illustration shows borrowing from the policy in the amount of $92,000 a year tax free each year until age 100.
Sound great, right? The client removed money from a taxable environment and put it into a tax-free environment.
The problems:
1) In order to get $92,000 as a loan from the policy, it used a 3.45% positive loan arbitrage on the borrowed funds (which was assumed from year 2 of the policy and lasted every year for 43 years). This was in an IUL policy that doesn’t have a fixed lending rate. Since the 50-year historical average lending rate on life policies is bit over 7%, I’d say this is as bogus as it gets.
2) If you used a lending rate 1% higher than the illustration I saw, the borrowing goes down to $79,000 a year. Why did I not use the 7% historical average? Because the insurance company software only allows me to raise the rate 1% from its current 4.25% default rate. If I illustrated with a 7% loan rate, the client would barely be able to borrow any money out of the policy.
You think that a client should be shown for full disclosure purposes an illustration with a 7% loan? I think so; and, heck, if the client was shown one with a 5.25% rate let alone a 7% rate, the agent would have no shot at selling this.
3) The numbers “as is” do not beat leaving the money in low-risk tactically managed strategies if purchased inside the IRA.
When I ran the numbers and compared them to my favorite .28% Beta strategy that has not had a down year in the last 21 years (an investment that is perfect for money in an IRA), the client could remove $96,000 a year (net of taxes) vs. the totally unrealistic $92,000 in the IRA illustration created by the agent.
Summary
The quick summary with this concept is that it’s a piece of garbage and should not be pitched to clients. I’m guessing that the agents pitching it either don’t understand the train wreck that awaits their clients or do and don’t care because of the massively high commissions that are paid.
As for the IMOs/GAs pushing this, I’ll let you make up your own mind if those are firms you should be working with.
If I get a call from a client who has been sold this concept, I will do everything in my power to help them understand what they’ve been sold; and I will offer my services as an expert witness in the lawsuit against the agent, IMO, and insurance company.
