Is “Tax-Free Retirement” Too Good to Be True?

Tax-free retirement—living a comfortable life in retirement without the obligation to pay income tax—comes as the result of planning and arranging your finances (following IRS guidelines every step of the way) so that when you retire, none of the money you receive is taxable—perhaps not even your Social Security income.

Tax-free retirement is good, and this article reveals how to make it happen.

Is Avoiding Taxes on Your Retirement Income Legal?

Reducing or avoiding taxes is perfectly legal. People take steps to reduce or avoid taxes all the time. They may donate to charity to avoid paying as much tax. They deduct their mortgage payments. They take legitimate business deductions. They may shift medical expenses, hoping to bunch expenses into one year and exceed the threshold for deductions that year. These are just a few of the legal tax-avoiding measures Americans take every day.

Many people even believe they have an IRA or a 401(k) to avoid paying taxes. But that’s a trap, because traditional IRAs, 401(k)s, and most other government-controlled retirement plans do not allow you to avoid paying taxes. They merely postpone tax day. We’ll talk more about that in a few minutes.

Over and over again courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands.” — Supreme Court Justice Learned Hand

So while avoiding taxes is legal, evading taxes is not. Maybe you don’t report your income. Maybe you take deductions you’re not allowed. Or maybe you just tell the IRS to take a hike. That’s tax evasion.

But make no mistake: A tax-free retirement can be achieved legally, using IRS-approved methods.

Ways to Avoid Income Tax in Retirement

There are steps you can take before retirement to avoid paying income taxes in retirement.

Will traditional retirement plans allow you to avoid taxes in retirement?

What about 401(k) plans, IRAs, 403(b) plans, and other government-controlled retirement plans? Are they tax-exempt?

No, with the exception of Roth IRAs.

Advisors who promote tax-deferred plans as ways to avoid paying taxes are perpetrating one of the greatest hoaxes in America.

Countless individuals have discovered—too late—that their taxes weren’t avoided. They were merely delayed (“deferred”) until retirement—often when they could least afford to be hit with a big tax burden.

The Society of Actuaries explains the true value of tax deferral:

The point is that a fully deductible tax-deferred account produces the same effect as a Roth that is taxed at the beginning and no longer is taxed. In both cases, a certain fraction of your money is left to you after taxes, and if those tax rates are identical, it’s the same fraction of your money that is left to you. It doesn’t make any difference whether it’s taken away from you at the beginning or at the end.”

But isn’t it smart to defer taxes until you’re in a lower tax bracket? More and more experts are saying “No!” to that question, as well.

Ann C. Logue writes about saving for retirement in Forbes:

The benefits of tax deferral assume that future tax rates will be significantly lower than today’s. Given the deficits faced by the federal government and by most states, however, it’s difficult to say that that will be the case. If the marginal tax rate you’ll pay in retirement is higher than the one you face today, you’re better off paying the taxes now, according to recent research published in the Financial Analysts Journal.”

If you want to begin thinking about tax-free retirement, stop thinking your tax-deferred retirement plans will help.

The only government-controlled retirement plan that is tax-exempt is a Roth IRA. But the government restricts the amount you can contribute to a Roth, so you probably won’t be able to build up enough cash for a comfortable tax-free retirement. We’ll show you how to supplement your Roth in a minute.

What about money in the government-controlled plans you already have?

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You are going to have to pay taxes on that money. Virtually every dollar you contributed to your government-controlled retirement plan was income on which you paid no income tax at the time. (Roth contributions are the exception.)

What will the tax rates be after you’ve retired? Many observers believe tax rates must go up due to government deficits and because of the increasing numbers of aging baby boomers receiving government benefits.

And there’s no guarantee your personal tax bracket will be lower in retirement. Many retirees we talk to say they’re finding themselves in a higher tax bracket.

Uncle Sam wants his pound of tax flesh. But you can pay your tax on the money one time, and never owe taxes on it again, if you move it into the proper financial instrument. We’ll tell you more in a moment.

Caveat: Money you withdraw from any tax-deferred plan increases your taxable income for that year. Don’t withdraw all your funds in one tax year, or you’ll blast your tax bracket for that year into the stratosphere. Work with a professional who can help you structure your departure from “tax-deferred” to “taxed-nevermore” so you pay the minimum tax necessary. That’s simply smart tax avoidance!

Other methods of reducing taxable retirement income

So the government isn’t much help when it comes to reducing your tax obligations, is it? Why should it be? The government wants every tax dollar it can legally get.

Where can you find good advice from someone who’s in your corner? It’s time to talk to a qualified life insurance professional.

A high cash value dividend-paying whole life insurance Policy may be the best way to accumulate wealth on a tax-deferred basis. You put in dollars on which you have already paid income tax. Then, as with a Roth IRA, you can access your principal and growth with no taxes due as long as your policy remains in force, under current tax law. This is accomplished through a combination of dividend withdrawals and loans against your cash value.

Life insurance offers other incredible tax advantages, which you can read about here.

High cash value dividend-paying whole life insurance policies are used by many, many knowledgeable individuals to fund tax-free retirement income streams.

What about your Social Security income? Will it be taxed?

Many people we’ve surveyed are shocked to learn that when they begin drawing Social Security, they’ll have to pay income tax on a major portion of it if they have other taxable income. And it doesn’t have to be much other income at all! Even taking the Required Minimum Distributions from their tax-deferred retirement plans can easily trigger taxes on Social Security income.

In the article, “Are My Social Security Benefits Taxable?” AARP explains: If you and your spouse file a joint return with a combined income between $32,000 and $44,000, up to 50 percent of benefits may be taxable. And if your combined retirement income is more than $44,000 annually, up to 85 percent of your Social Security income will be taxed as income.

But guess what? If you follow the rules, the money you take from your Bank On Yourself-type life insurance policy isn’t considered to be income.

First, dividends you withdraw (up to the amount of premium you’ve paid in) are generously characterized by the IRS as “return of premium paid” (in other words, not taxable). So to take money from your Bank On Yourself-type life insurance policy, it’s best to withdraw those dividends first. Then you borrow against your cash value.

And second, policy loans against cash value aren’t income. They’re just loans.

If your only income during retirement is from Social Security, plus life insurance dividend withdrawals and policy loans, plus less than $32,000 from other sources, your Social Security probably will not be taxed, under current tax law. (We have to say “probably” because there are exceptions to everything. So consult your tax advisor for specific advice based on your situation.)

Caution: Not All Permanent Life Insurance Policies Can Give You Worry-Free Tax-Free Retirement Income

Beware of books that promote the use of life insurance to create a tax-free retirement—if they recommend any form of life insurance other than dividend-paying whole life!

For example, in his book Tax-Free Retirement, Patrick Kelly advocates using universal life insurance. Others recommend indexed universal life insurance.

But whole life insurance gives you more guarantees than any other type of permanent life insurance. This article compares universal life with whole life, so you can decide for yourself.

Indexed universal life insurance has no place in a worry-free retirement plan. This article reveals 7 Reasons to Be Wary of Indexed Universal Life Insurance.

What Are You Waiting For?

The key to tax-free retirement income is planning. The time to start planning was probably yesterday, but today is the second-best time.

Request a FREE, no-obligation Analysis and find out how much tax-free money you could have in retirement. You’ll receive a referral to an Authorized Advisor (a life insurance agent with advanced training on this concept) who will prepare your Analysis and Solution. There is no cost for this service, and no obligation on your part.

The Truth About Whole Life Insurance and Why It’s More Than a “Rich Man’s Roth”

I came across an online article by an anonymous blogger who claimed that the only good purpose for whole life insurance was as a rich man’s Roth. He was certain whole life insurance was only for individuals whose high incomes made them ineligible for the tax-saving advantages of a Roth IRA.

That’s actually pretty funny. Why restrict the incredible advantages of whole life insurance—including the tax advantages—only to the wealthy?

Let’s look at how a Roth IRA works and then compare it to a Bank On Yourself-type whole life insurance policy.

How Does a Roth IRA Work?

A Roth Individual Retirement Arrangement (Roth IRA) is an IRS-approved strategy that allows you to invest money you have earned by making contributions to a Roth IRA plan you have set up. You are not allowed to take a tax deduction for your contribution as you are with a traditional IRA. However, none of the money you take from your plan in the future is taxable. As far as the money in your Roth IRA is concerned, you will not be affected by future changes in the tax rate.

How a Roth IRA differs from a traditional IRA

Roth IRAs are quite different from traditional IRAs.

Chart Comparing Key Differences Between Traditional And Roth IRAsWith a traditional IRA, your contributions are tax-deductible. However, when you withdraw money from your traditional IRA—and you must withdraw specific percentages annually, beginning soon after your seventieth birthday—you must pay taxes on everything you withdraw—at whatever the tax rate happens to be at the time.

See the table for a summary of the key differences between a Traditional IRA and a Roth IRA. [Read more…]

The Surprising Truth About What Happens to the Cash Value of Your Life Insurance Policy When You Die

In Part 1 of this two-part series, I proved the media’s financial gurus are wrong when they claim that it takes years to build cash value in a whole life insurance policy.

In this second part of the series, I’ll show you why all the self-proclaimed experts miss the boat when they claim that whole life insurance policies are a rip-off because you build up all that cash value, then the insurance company keeps it when you die and only gives your heirs the death benefit.

It doesn’t have to be that way, my friend!

Click on the policy statement above to see a larger version

Here’s an actual whole life insurance policy annual statement. (This is a different policy than the one I showed you in Part 1.)

This is a whole life insurance policy purchased on my life in 1992. The statement I’m showing you, issued 17 years later, makes some astounding revelations. [Read more…]

Here’s Proof That the Financial “Experts” Don’t Know About Bank On Yourself Whole Life Insurance Policies

Policy Statement Showing How Whole Life Policies Designed the Bank On Yourself Way are Different From the Policies Most Financial "Gurus" Talk About

Click on the policy statement above to see a larger version

Take a look at this life insurance policy statement. It’s for a policy I took out on September 15, 2002. I’m showing it to you because I want put to rest the misconceptions and untruths the so-called financial “gurus” are spreading about the cash value growth of well-designed dividend-paying whole life insurance policies.

The financial gurus tell you not to buy whole life insurance because your equity in the policy—your cash value—grows too slowly, and you won’t have any equity for the first few years.

This is simply not true of Bank On Yourself-type whole life insurance policies!

You’ll have cash value in the first year with a whole life insurance policy designed the Bank On Yourself way!

[Read more…]

21 Reasons Life Insurance Policy Owners Love the Policy Loan Feature

We recently published a 3-article blog post series inspired by an article that financial planner and investment advisor Michael Kitces wrote about the problems with “banking on yourself” with life insurance policy loans.

Then we invited our readers to tell us what their biggest take-away from these articles was, and to share their personal experience with Bank On Yourself policy loans versus other sources of financing.

The many comments left on these three blog posts demonstrated once again how insightful and articulate our readers are! We’ve published excerpts from some of the comments we received below, where you’ll find 21 reasons why using a Bank On Yourself-type policy loan to access cash beats any other way of accessing capital!

In the first article, we discuss four things Mr. Kitces got right about the Bank On Yourself concept, and then reveal what he got wrong, including five fundamental concepts.

Check out What Michael Kitces Missed in His Bank On Yourself Review, Part 1. [Read more…]

The 8th Wonder of the World? Here’s proof

Recently we “ethically bribed” our readers into learning more about what I’ve called the “8th Wonder of the World.”

You see, the two most common reasons people have for adding the Bank On Yourself method to their financial plan are:

  1. To grow wealth safely and predictably every year – no matter what’s happening in the market or the economy – and to protect themselves from losses in future market crashes
  2. To become their own source of financing when they want to make a major purchase or when an emergency expense comes up – so they can get access to money when they need it and for whatever they want – no questions asked

The second reason – the ability to become your own “banker” – is so compelling that once people use that feature of their Bank On Yourself plan, they often write to tell us what a powerful and emancipating feeling it is. [Read more…]

Michael Kitces’ Big Blind Spot on Bank On Yourself Policy Loans

In his review of Bank On Yourself, Michael Kitces repeatedly harped on the worst-case scenario of a life insurance policy owner taking out a life insurance loan with no regard for ever paying it back.

Kitces rightly pointed out there could be significant tax consequences if a life insurance policy were to lapse due to a large policy loan.

If the interest is not paid, it gets added to the loan balance. Eventually the loan balance could come so close to the cash value securing the loan that the life insurance company—after giving fair warning—would take the cash value to pay off the loan, causing the policy to lapse.

What Kitces didn’t mention is that if the loan balance ever does exceed the available cash value, paying some or all of the loan interest out of pocket generally solves the problem. And he didn’t tell you about the option of taking a policy “reduced paid-up,” as I discussed in our previous article on this topic.

So, we agree with Michael Kitces that a growing loan can cause a life insurance policy to lapse.

But Kitces mostly talks about “when the policy lapses.” Huh? “When”? That’s an odd assumption. It’s like saying, “Don’t take out a mortgage to buy a home, because when you default on your loan …”

Does he really think we are that irresponsible? [Read more…]

Here’s What Michael Kitces Missed in His Bank On Yourself Review, Part 2

In part 1 of this article, I explained that financial planner and investment advisor Michael Kitces wrote a review of the Bank On Yourself concept that redefined my trademarked phrase, “Bank On Yourself” to fit his interpretation of how the concept works.

Now I’ll show you how Kitces missed five critical key requirements of the Bank On Yourself concept—and why it’s so important that you don’t make the same mistake.

To review, to truly be banking on yourself

  1. You must use a dividend-paying whole life insurance policy
  2. The policy must have a “non-direct recognition” policy loan feature
  3. The policy must incorporate a flexible policy design
  4. You, as the policy owner, must be an “honest banker”
  5. You must work with a knowledgeable advisor

Let’s See How Michael Kitces Misunderstood—or Simply Missed—Each of These Five Requirements of Bank On Yourself:

1. You must use a dividend-paying whole life insurance policy

[Read more…]

Here’s What Michael Kitces Missed in His Bank On Yourself Review, Part 1

Financial planner and investment advisor Michael Kitces understands a lot about many areas of money and finance. He has been to school. He has twice as many letters after his name as he has in his name. Literally.

Surprisingly, Kitces does not understand some basic fundamentals of the Bank On Yourself strategy for personal finance.

Kitces wrote a review of the Bank On Yourself concept. And while he got some of the fundamentals right, he missed some very important points.

From time to time, readers ask us about Kitces’ article, so I want to clear up the misconceptions in it. I’ll cover four things he got right about the Bank On Yourself strategy, then I’ll reveal the things Kitces got wrong—including five fundamental concepts.

Here’s What Michael Kitces Got Right in His Bank On Yourself Review …

In his Bank On Yourself review, Michael Kitces correctly stated four things:

1. Kitces: Permanent life insurance “gives an insurance company the means to provide policy owners a personal loan at favorable interest rates, because the cash value provides collateral for the loan”

Well stated! You can’t take out a life insurance policy loan unless you have a life insurance policy with enough cash value to serve as collateral for the loan. And the interest charged for policy loans is generally at competitive, below-market rates.

2. Kitces: “Even as cash value life insurance operates as collateral for a life insurance policy loan, it also remains invested, earning a rate of return that slows the erosion of the net equity in the policy”

[Read more…]

The Bank On Yourself No-Nonsense Guide to Life Insurance

Life insurance is a subject we don’t like to think about. It’s right up there with going to the dentist and writing the annual Christmas letter. (Do people still even do that?)

Thinking about life insurance is one more reminder that we may not live forever. Ugh.

But not going to the dentist doesn’t make things better. And not thinking about life insurance won’t help you live longer.

On the other hand, going to the dentist and thinking about life insurance are two really positive things you can do that are almost guaranteed to make your life better.

If peace of mind, a sense of security, and the knowledge that you’re doing all you can for your family and yourself are important to you, then it’s wise to spend a little time thinking about life insurance.

But life insurance doesn’t have to be complicated or boring—which is why we created this Consumer-Friendly Guide to Life Insurance.

Here are some interesting facts about life insurance that we cover in our Guide. Did you know that …

[Read more…]