Recently, I had an adviser contact me to get my opinion of a sales platform. This happens several times a year. When he told me what it was, I knew instantly the numbers were risky and that the strategy would not make sense.
Another IRA/401(k) rescue plan
Life insurance sales people are continuously trying to figure out how to get money out of an IRA so they can tell clients to put the remaining money (after tax and potentially a 10 percent penalty) into cash value life insurance.
The sales pitch is always that IRAs are tax-hostile and that cash value life is tax favorable because money can grow tax free and come out tax free. No one knows this more than I do. I’ve written about this in several books, and specifically deal with the math comparing tax-deferred IRAs/401(k) plans vs. cash value life as an after-tax, wealth-building tool.
"Fund life insurance and borrow from the policy in year two to pay the incomes taxes due on IRA/401(k) distributions"
The above title says it all. Let me give you the fact pattern: The client is age 61 and she has $500,000 in an IRA. The goal is to show the client why it is better to cash in the IRA over a five-year period at $100,000 a year and fund a cash value life policy (with the after-tax remainder) vs. letting the money grow in the IRA and take taxable distributions from ages 77–86.
It only took me a few minutes to run the numbers illustrating why this is a terrible idea. The client would pay a $100,000 life insurance premium each year from distributions from the IRA. Then the client would borrow $40,000 a year from the life policy in years two through six to pay the taxes on distributions from the IRA (assuming a 40 percent income tax rate).
The sales pitch is that the client can take money out of the IRA and feel no financial pain because money from the life policy is used to pay the taxes. Then the client would let the cash in the policy grow and would be able to borrow out $40,000 a year tax free from the life policy from ages 77–86 (10 years).
The illustration I was provided was fairly conservative, which surprised me. If the illustration was more typical — maximum crediting rate with minimum non-guaranteed loan rate — the $40,000 non-guaranteed amount would be higher and could potentially be borrowed out until age 100.
Is this a good idea? Absolutely not; the math is crystal clear.
What if the client took the $500,000 in the IRA and put it into the best fixed indexed annuity with a guaranteed income rider? How much could she receive starting at age 77 as her guaranteed income for life benefit? Approximately $113,056 a year, every year, for the rest of her life, not just for 10 years.
If she is still in the 40 percent tax bracket in retirement (which may or may not happen), she would have $67,833 left after tax every year, for life.
Which do you think a client would like better? $40,000 tax free from ages 77–86 (non-guaranteed) or $67,833 every year for life guaranteed (which could be until age 100+). There is no comparison.
Bad advisers sell concepts that are not in their clients’ best interests
This is a classic sales platform that should not even exist. What’s worse is the idea came directly from a home office employee at an insurance company.
If you receive this sales pitch from an insurance company, run the numbers yourself; but as you can see, I’ve run the numbers and they do not and will not work.
In the end, this sales concept is just another in the long line of concepts being pitched in our industry that are not good for consumers.