So you need cash for retirement income, or a business venture, or your kids’ education…and you have an Indexed Universal Life insurance policy? I’m going to show you the smartest way to access the cash you need, entirely income-tax-free.
If you’re familiar with my work at all, you know that for over 45 years I’ve been helping people optimize their financial assets. I’m very passionate about helping people minimize taxes so they don’t outlive their money in retirement. You’ll also know that maximum-funded, properly structured Indexed Universal Life policies (what I call LASER Funds) are one of my favorite vehicles that I recommend for their superior liquidity, safety, predictable rates of return, and tax advantages.
Through helping clients move their serious cash into LASER Funds, we’ve taken some folks from being in the highest tax bracket to essentially a 0% income tax bracket. We can’t always do that for everyone, but if the circumstances allow, there is great power in this strategy. As an example, we actually have clients that have $8 million in their portfolio of LASER Funds, generating, very conservatively, between $600,000 to $800,000 a year of growth or tax-free income for as long as they live, without depleting principle.
This is where some people question, “How is that possible? Won’t the IRS shut that down?”
Nope. The IRS knows they’re accessing that income, and the IRS knows it’s perfectly income-tax-free because their very own IRS codes make it so. Income accessed the smart way from IUL policies is not deemed “earned, passive, or portfolio income.” And ever since the 1986 tax reform, those are the only three types of income you pay income tax on in America. (Take a peek, it’s on the front page of your 1040 tax return.)
Compare that to income you can access from your 401(k) or IRA. Because the money you put into those traditional accounts is typically pre-tax, you’ll pay taxes on the harvest vs. the seed. I’ve often had people talk to me about all the money they’ve set aside in yet-to-be-taxed IRAs or 401(k), saying, “Hey Doug, we’ve saved $3 or $4 million in our accounts. We figure we can experience about $200,000 a year of retirement income.”
I say, “Well, that’s great. Way to go. High five. But the big problem I see–it’s all showing up on the front page of your 1040 tax return. You’ll be paying income tax on the money you withdraw.”
And they pause, “You mean, there’s a better way?”
Yes, there is. The LASER Fund allows you to access cash from your policy for virtually anything you need–emergency funds, business investments, real estate purchases, and of course retirement income, income-tax-free. I’m such a fan of its liquidity, safety, predictable rates of return, and tax advantages that I would recommend putting between 40% to 60% of your retirement income in LASER Funds.
To understand more about what an IUL is and how it works, check out this blog article and YouTube channel video. For the rest of this article, we’ll assume you understand LASER Fund basics so we can focus on the smartest way to access the money in your LASER Fund.
In my books and videos, sometimes I explain there are three ways you can access money out of a LASER Fund:
- The sad way
- The dumb way
- The smart way
THE SAD WAY
In a nutshell, the sad way is by dying. As an example, if I put in, let’s say $100,000, the death benefit is $2.5 million, and I die the next day, my beneficiaries will receive the 2.5 million death benefit income-tax-free. That’s one heck of a return, but I don’t recommend the sad way until it’s time, okay?
As a side note, compare that to money you might have in an IRA or 401(k). When you pass away, the money in your 401(k) will go to your beneficiary—but so will the tax liabilities. Unless it’s rolled over to an IRA, with most 401(k) plans, the money is paid out as a lump sum to the beneficiary no later than December 31 of the year following your death—with income taxes due that same year.
(Note, if your beneficiary is your spouse, she or he will have the option of keeping it in your name or rolling it over to her/his own 401[k], but will need to make mandatory withdrawals after age 70½, which then become taxable income.) With any IRA or 401(k) that is inherited, your beneficiaries are responsible for taxes on the account, whereas with life insurance, your heirs will not pay any income taxes on the tax-free death benefit you pass on.)
THE DUMB WAY
What about the dumb way? There are a few dumb ways to access money from your LASER Fund. The first would be to surrender your policy, which would trigger taxes on any gains your policy has earned. What’s more, if you surrender the policy within the first ten years, you would pay surrender charges (unless you had specifically purchased a rider to waive surrender charges).
Another dumb way would be to withdraw more money than you’ve put in during those first five years on average that you’re funding your policy. Life insurance policies are taxed FIFO (meaning the first money you put in, is the first money you take out, and that’s the money on which you’re taxed).
Once it’s fully funded, if you were to continue withdrawing money (rather than borrowing it from the policy in the form of a loan), you would incur taxes, as well. Again, this is where it’s critical to work with an IUL specialist who is experienced with LASER Funds to ensure you’re accessing your money correctly.
THE SMART WAY
Are you ready for the smart way? The best way to access cash in your LASER Fund is by taking a loan on your policy.
There are a few things to keep in mind with loans. First, you never want to borrow more than 80% to 90% of your cash value. Your cash value is the actual amount that is liquid, and it’s based on your accumulation value minus surrender charges, or penalties for early cancellation and any outstanding loan balances on the policy. (This is another reason you want an expert IUL specialist who can help ensure you leave minimum balances required by the policy to avoid creating a taxable event or surrender charges.)
If you choose to take withdrawals up to the basis, it is tax-free. But after recovering your basis, the Smart Way to access your money would be to begin taking out tax-free loans. Otherwise, you will trigger unnecessary tax. We typically do not recommend taking withdrawals up to your basis, because withdrawals are permanent, and you cannot put the money back into your policy. With a loan, however, you can always repay your loan by putting money back into your policy.
You may be wondering, “Why borrow your own money?” Here’s what happens. Let’s say I have $1 million of cash value in my policy. If I leave it there as collateral for my loan, it will keep growing. If instead I were to take it out (by withdrawing it), it won’t grow anymore, right?
Instead, I tell the insurance company, “Leave my million there earning 5%-10% (based on historical averages), and loan me $100,000.” Since loan proceeds are not deemed earned, passive or portfolio income, that $100,000 is income-tax free. It’s that cut-and-dry. Income-tax-free. Period.
When done correctly, it is a loan made to yourself that is never due in your lifetime. Your loan can be paid off against the death benefit when you pass away, with the balance of the death benefit going to your beneficiaries, income-tax-free.
To be in compliance with IRS guidelines, an interest rate is typically charged on your loan, but then that interest is offset with interest that is credited on the money you didn’t “withdraw” but rather, remained there as collateral for your loan, thus resulting in a zero net cost in many instances.
You can choose a zero net cost loan (which is often referred to as a Zero Wash Loan), or you can also choose an Alternate Loan (some companies call this an Alternative Loan, Participating Loan, Indexed Loan, Variable Loan, or a Spread Loan). Essentially these types of loans allow the money in the insurance policy (e.g., the cash value that is collateral for the loan) to continue to earn the indexed rate (which typically averages 5% – 10% tax-deferred).
What’s more, you can borrow the money at any time, at any age, with no penalty. Compare that to traditional accounts like IRAs and 401(k)s, where you pay a 10% penalty in addition to income tax when withdrawing money before age 59 and ½.
Another reason accessing cash the smart way makes sense? It’s helpful in cases of a sudden windfall of cash.
As mentioned above, you don’t ever have to pay it back during your lifetime. So let’s say you’ve been borrowing $100,000 a year from your policy for 20 years, and your loan balance is now $2 million. Now let’s say you suddenly come into a large sum of serious cash, let’s say $2 million for simplicity. It could be from an inheritance or the sale of a business.
You couldn’t put all that into a traditional account like an IRA immediately–there are limits on how much you can contribute each year (currently just $6,000 a year if you’re under age 50, $7,000 if you’re older).
But here’s what you can do with a LASER Fund. You can drop that $2 million into your policy as a repayment on your loans. You don’t even have to open another LASER Fund policy (which may be difficult if your health situation has deteriorated)–you can just use the policy you already have!
As you can see, the LASER Fund allows you incredible flexibility to access cash when you need it. And when you do it the smart way, you’re doing so income-tax-free. This article gives you a quick overview–for a deeper dive, I invite you to read my book “The LASER Fund” and catch up on my YouTube channel.
WANT TO LEARN MORE?
Watch the Video – Watch the related YouTube video to see me explain “What Is the Smartest Way to Access Cash Out of an IUL?” (and while you’re there, be sure to subscribe to my YouTube channel so you don’t miss a thing!).
Elevate Your Financial Dimension – Find out how you can improve your Financial Dimension journey and seize the liquidity, safety, predictable rates of return, and tax advantages of a LASER Fund. Explore the in-depth financial strategies and learn from real-life client experiences by claiming your free copy of “The LASER Fund” book at LASERFund.com. Just pay for shipping and handling, and we will send it to you, absolutely free.
Join a Webinar – Want to find out if a LASER Fund (a maximum-funded, properly structured indexed universal life insurance policy) is right for you? Join us for an upcoming webinar where you can explore these strategies.