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Published On
November 2, 2021

In what order you should contribute into which accounts for retirement? Joe & Big Al explain the reasoning behind the sequence of retirement savings, and where a health savings account (HSA) fits in that sequence. Following some retirement plan spitball analyses and Roth conversion strategizing, the fellas explain whether capital gains are taxed progressively, how required minimum distributions are taxed, and they revisit indexed universal life insurance.

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Show Notes

  • (00:49) Where Does HSA Fit in the Sequence of Retirement Savings? (Craig, MI)
  • (07:09) Retirement Spitball: Where to Contribute? (Lee, Jacksonville, FL)
  • (12:05) Roth Conversion Strategy Follow Up and Mortgage Payoff (Annie, TX)
  • (16:10) Retirement Spitball: Why Do the Experts Say I Have To Work to 70? (Paul, NJ)
  • (19:12) Are Capital Gains Taxed Progressively? (James, AZ)
  • (24:30) What’s the Tax Rate on My Required Minimum Distribution? (podcast survey)
  • (28:40) Should We Keep Our Indexed Universal Life Insurance Policy? (Em, Florida)

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LISTEN | YMYW PODCAST #325: Capital Gains vs. Ordinary Income Tax Explained

LISTEN | YMYW PODCAST #246: Why This Life Insurance is for the Most Part a Scam(IUL, Indexed Universal Life Insurance)

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Transcription

We often hear about what order you should contribute into which accounts for retirement savings. Today on Your Money, Your Wealth® podcast #350, Joe and Big Al explain the reasoning behind that sequence of retirement savings, and where an HSA, a health savings account, fits into that sequence. Following some retirement plan spitball analyses and Roth conversion strategizing, the fellas explain whether capital gains are taxed progressively, how required minimum distributions are taxed, and what the?! they also revisit indexed universal life insurance, a favorite topic of days gone by. Plus, Joe’s got a second career in the works, and we’ve got Derails galore. I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

Where Does HSA Fit in the Sequence of Retirement Savings? (Craig, MI)

Joe: Answering money questions again got Craig from Michigan, writes in. He’s like wondering how you see HSA fitting into a retirement portfolio? I’ve noticed in listening to your podcast, the order you suggest, is (1) 401(k) the match, (2) max out Roth IRA if eligible (3) go back and max out 401(k), (4) money into brokerage account and then (5) which Craig missed here is look at conversion opportunities.

Al: There you go. Wow. Yeah.

Joe: And why? Why is that? Why do we why don’t we talk about that? Is if you do it this way, you’re automatically going to be diversified tax wise, if you do this long enough.

Al: Right. Because you’re at least we know you’ll have something in the Roth IRA as long as you qualify for it.

Joes: So most people just go 401(k) that put their blinders on, and that’s all they save into.

Al: Right.

Joe: And then, you know, 30 years later, they got a couple or a million bucks in their 401(k) plan and no other assets.

Al: You know, and if you’re just starting out and you only have a couple of thousand to invest, you’re probably just going to be doing number one only, 401(k) match. But as you add to your savings, this would be a good order till you kind of get to number four, which is put any extra into a brokerage account.

Joe: So all right back to Craig on with HSA providing an initial tax deduction, retirement free growth in tax free distributions on eligible medical expense, where would you put contributing to an HSA in the order above order of retirement funding as long as someone is comfortable with a high deductible insurance plan? I see this after three in the order above, if not after two. Thanks for everything you all do on this podcast. I learned so much over the past year listening to you and I have laughed along the way as well. I have a cockapoo that I walk as I listen to your podcast.

Al: Like like a toy?

Joe: Yeah, cute little thing. OK, so where would you put or HSA, I’ll explain what an HSA is.

Al: Well, it’s a it’s a health savings account. It’s a savings account. You have to have a high deductible health insurance plan. So many of you don’t qualify, but let’s just assume that you do qualify.
In other words, you have a high deductible health insurance plan. An individual could put away $3,600 per year, a married couple $7,200 a year into the plan. And then if…

Joe: You receive a tax deduction for the $3,600.

Al: That’s right. And then it grows tax free as long as the money is pulled out for medical expense. So it’s actually one of the best accounts there is, right, because you get a tax deductible and tax free growth and you never pay tax on it, so it’s actually pretty useful.

Joe: Now then let’s say you have money that’s accumulated in there, but if you don’t use it for qualified medical expenses, then it’s taxed or after age 65, I believe, or once you’re Medicare eligible.

Al: 65 Yep.

Joe: Yeah, you are no longer eligible to use or to contribute to an HSA.

Al: Right. It’s not only if you use it for something other than qualified medical expenses, you have to pay the tax on the income. Well, it’s all income and so there’s no basis for it to have to pay tax on the whole thing, plus a 20% penalty until you hit age 65.

Joe: And then you can run into an IRA.

Al: You could and then you could augment, right? Also, you can just pull money out for non-medical expenses and just pay tax, not the 20%. But the thing is that the reason why it’s there’s so much benefit there is qualifying medical expenses are pretty broad and virtually all of us, all of us are going to have that over the course of our lifetime. So to get a tax deduction and have it grow basically tax free and you pull it out and never pay tax, it’s it’s pretty useful. So the question is, where would you put it on this chart?

Joe: Al I would go for 401(k) for the match and maxed out my Roth IRA. Go back, max out my 401(k) with the money into a brokerage and then HSA. Now I don’t have an HSA, so right. So I don’t know. I get his point. I think is probably after two right after you Max IRA.

Al: I think Craig, you’re right on track. You could argue it’s after two or three. Depending upon how you want to think about it, it’s probably it’s probably more valuable than going back to your 401(k) just because of the tax free nature of it. But if you if you’re very healthy for the next 25 years, it’s it’s almost kind of it’s going to feel like lost money in a way I don’t know.

Joe: Right? I mean, that’s also assuming that you’d never have to use it for medical expenses, right?

Al: Right. You know what I mean, which you probably will. I mean, you could.

Joe: Yeah, pretty healthy and I had back surgery. Fine. Right.

Al: And I know, right?

Joe: I mean, that wasn’t cheap, right?

Al: Well, and of course, the idea you have a high deductible health insurance plans. So if you do need something like back surgery, you’re out of pocket $10,000 or whatever the numbers, right?

Joe: Right, yeah. So yeah, I like HSA quite a bit. I guess we don’t really talk about them all that much now because…

Al: Yeah, most people don’t have them. But Craig, I think you’re on the right track. I think you could put it after two or after three it doesn’t really matter.

Joe: Yeah, and you can invest HSA plans to just like a regular IRA or a brokerage account. You could have it in cash. You may have like almost a debit card where you go to CVS and you know you buy your whatever that you need, and I don’t know what the auditing system is on each side.

Al: I don’t think very much. I think I have.

Joe: So if I go to, let’s say, I have an HSA plan. I go to CVS, and I buy a case, of Coors Light, things like…

Al: I just knew you were going there, right?

Joe: Yeah, I mean, I don’t know. I’m going to set it and I need medical attention, but I’m a little bit.

Al: Well, let’s face it, that’s how you relax. Part of your R and R.

Andi: Yes. Well, you have set items that you are and are not allowed to use, I believe, and I don’t think Coors Light is on the list.

Al: No, no. But the question is, do they audit it. The answer is I’ve never heard of that.

Joe: But if it’s a debit card, right, you know, and they bring up Coors Light and I put it on the debit that my ex-girlfriend had, like the HSA debit card

Al: Yeah right, and like use it for whatever. So, yeah, the thing is, and this is true. Taxes in general, you can do whatever you want until they question it.

Joe: Yeah, you’re on the honor system.

Retirement Spitball: Where to Contribute? (Lee, Jacksonville, FL)

All right. We got, “hello again, Big Al, Joe and Andi, not necessarily in that order. This is Lee from Jacksonville, and I appreciate that you answered my question in podcast 338.”

Andi: Just so you know that was asking about your opinion on structured notes.

Joe: Got it. Um, what did we say? Did we say we loved them, hate them?

Andi: You don’t even know what you said.

Joe: No, I know.

Al: I know what you said, Dave. I will do this question.

Joe: I have a new one that I probably should have asked first, as it’s more important to our path towards, well, I receive 100% VA disability and will for the remainder of my life, as I’m categorized as totally and permanently disabled. In addition, if I kicked the bucket before my wife, she receives a dependency compensation check each month. We are pretty far from retirement, I’m age 45, and she’s 43 probably will only need about $60,000 or $70,000 in today’s dollars each year, when we get there. I currently receive $40,000 a year that increases with COLA like Social Security. Due to my V.A. status, I am covered 100% for medical, dental and vision and my spouse also receives medical insurance through me, which will cover any cost as a secondary insurance to Medicare in the future. We have about 13 years left in our mortgage, and it’s done. Wife makes $130,000 a year and plans to retire at age 64. All this is to say that we have a significant amount of cost covered in retirement since we have current retirement accounts totaling $500,000. We also have about $30,000 sitting in cash. Is it your opinion that reducing the risk on these investments in the current contributions towards both max Roth IRAs and max traditional 401(k)s is a smart move, given that we are guaranteed a good income in retirement from both my V.A. compensation and future Social Security, virtually all of our expenses will be covered without needing much of the retirement money. Thanks again for ideas on this. So, OK, V.A. compensation he’s making $50,000 a year with the COLA. That’s all tax free. So my strategy for Lee from Jacksonville is going to be a little bit different than because he’ll have room in the 0% tax bracket and the lower brackets. So I don’t know if I would fully fund Roth, but he does have $175,000 in the IRA already. I would want to run some numbers out, probably split it just to. And let’s see $130,000 there in the 12, the what, 22% tax bracket. They’ll be in the 0% tax bracket, probably in retirement.

Al: Yep, I would say so. And plus with the VA income that is tax free, probably the Social Security will be tax free too. So the only thing that could trip that up would be RMDs. Yeah. Yeah.

Joe: But he could he could convert, you know, if they I mean, I don’t know who knows what the hell is going on, and they’ll probably get rid of conversions here soon.

Al: So in the next decade, we’ll see.

Joe: Yeah. In the next decade. Yeah. Just because one guy got like a billion dollars in his Roth, the two. Well, it’s kind of ruin it for everyone. Right? So I don’t know. This is a tough one. Just but here’s what I would do Lee. You just run some numbers a little bit and they get on an Excel spreadsheet and then kind of map this thing out. I don’t know, because a lot of your income is going to be tax free. The RMD is the only thing that’s going to blow them up. Yeah. And I’m just not sure at his young age. 45, and he’s already got a lot. Most people won’t have that big of fixed income, large fixed income to cover all of his expenses. And it’s all tax free. So here, he’s sitting really pretty. I don’t know. Just maybe bite the bullet and do as much Roth as you can until the big change to the law.

Al: Yeah, I’ll go with them.

Download our Retirement Readiness Guide for free from the podcast show notes at YourMoneyYourWealth.com to do your own spitball, see if you’re on the right track for retirement, and learn strategies that can help you get there. From the show notes you can also access other free financial resources, you can Ask Joe and Big Al your money questions, you can share YMYW to spread the word and help us grow, and you can schedule a free, one-on-one, comprehensive financial assessment at a date and time that’s convenient for you with a professional on Joe and Big Al’s team at Pure Financial Advisors. To get started, simply click the link in the description of today’s episode in your podcast app.

Roth Conversion Strategy Follow Up and Mortgage Payoff (Annie, TX)

Joe: “Hello again, Pure Financial Crew.  I was so excited when you aired my email but was kicking myself when I did not provide that one piece of info regarding my income. I make $80,000 and my husband makes $40,000.  I was hoping to optimize taxation so I was thinking of converting to Roth when I went part time. I will be making $40,000 at that time. Al so intelligently questioned why we had so little in our brokerage account. Joe said that maybe something major had happened.  Both of you are correct.”

Al: Yeah.

Joe: Oh wow. Don’t even know Annie from Texas. Yeah, we already like it. Yeah, we had a little start, had a little late start investing. We paid off our mortgage about three years ago. That was the major change that sent me on this journey. We use the money that was previously going to rent and started investing for retirement. I know many financial advisors do not recommend paying off your mortgage, but in my case it was the best thing. It freed up so much income. We bought too much home and 45% of our income went to the mortgage every month when we paid off the mortgage. We did not inflate our lifestyle. We learned to budget and invested what would be going to the mortgage. I’ve attached a previous email in hopes you could answer my original question. I know Joe was thinking I could just throw everything at the Roth 401(k), but. Now, but would that be the best strategy in our situation, we are very disciplined, you know, we’d like to stick to the best tax optimization plan you spitball for us. Yes, I would still stand by my recommendation or spitball.

Al: Yeah, you always go with that. It’s Roth 401(k).

Joe: Roth or Die, baby. Oh, OK, so the well…

AL: …what was the original question?

Joe: Um, ok. At age 50 we’ll stop making these contributions. Do you recommend that change my 401(k) contribution style to Roth 401(k)?

Al: So that was yes.

Joe: Yes. Do you recommend I change my allocations now and add more moneys in to brokerage? I wouldn’t max out Roth 401(k) on maxed out Roth IRAs. And if there’s still money left, yes, then you would want to go to your brokerage account.

Al: We also have how much should I convert? That was the remeber? She said that they made $120,000. We didn’t really know how much was his versus hers. Yeah, but now we do know that. So she makes $80 hubby, makes $40, that’s $120. She’s going to go to half time and make $40. So $40 plus $40 is $80, is it? Yep. Okay. He’s got a calculator top to top of the top of your game to buy the game right now. So. And if you’re if you’re going, if you want to convert to the 12% bracket, that’s $80,000. Now you get a $25,000 deduction roughly for standard deduction, which means in that example, you could convert about $25,000 and still stay in the 12% bracket. You know, you could add another $80,000 to that, so you’re well over $100,000 to stay in the 22% bracket, something like that. So it depends upon what bracket that you are eventually going to be in.

Joe: Yeah, I think you just go to the top of the 12.

Al: I think so. I mean, basically looking at the assets that you’ve accumulated so far. Yup. Yep.

Joe: Go to the top of the 12 right for Roth 401(k)s Roth IRAs. And then look at your tax return and say, OK, where do you think you’re going to fall? Just remember, the top of the 12% tax bracket is $80,000 of taxable income, not gross income.

Al: Yeah, that’s important. So that that’s $120, $105,000 of gross income minus the standard deduction, it actually gets to $80. So $100-105,000 is kind of your target for income.
So if you’re at $80 now at another $25,000 Roth conversion and you’re there.

Joe: So as you are working full time making $120,000, I probably would not do any conversions. I would just do the Roth 401(k), Roth IRAs. And then once you got a part-time, then I would start doing the conversions of, you know, 10 to $25,000 a year to stay in that 12% tax bracket.

Al: Yeah.

Joe: OK. Thanks, Annie, for the follow up.

Retirement Spitball: Why Do the Experts Say I Have To Work to 70? (Paul, NJ)

OK, we got Paul from New Jersey. “My wife and I make about $200,000 a year combined using the 80% rule that says we need about $160,000 a year,” 80% rule of gross is what he’s saying here. OK?

Al: Yes, I think that’s what he’s saying.

Joe: All right. “Yet when I subtract out the money, we never see taxes, Social Security, unemployment insurance 401(k) IRA contributions. We spent about $83,000. I will get a $32,000 pension, have about $1 million in deferred accounts and $240,000 in Roths. Using that $83,000 number, I think I can retire at 60, accounting for 2% inflation, health care premiums included. What am I missing? Why do the experts tell me I have to work until 70? Signed, confused 60 year old.” All right, Paul, you’re right on track. Brother, ignore the experts. Or maybe you’re confused on what the experts are saying. You look at what your income, your spendable. What are you spending, right? Right. It’s not necessarily you’re replacing 100% of your gross.

Al: Yeah, you hear that. You know you’re going to you need to replace 70% of your income. It’s like, well, is that 70% of net or a gross? No one ever says that. Don’t even think about that. Take a look at what you’re spending so you know what you’re spending, which is great.
A lot of people don’t if you don’t know what you’re spending. Look at what your net pay is for payroll and multiply it by the number of payrolls you get paid once a month. $10,000 bucks. $10,000 times 12 months. 120. That’s probably what I’m spending, right? Right. Maybe, maybe you’re having to dip into savings and so you spend a little bit more or credit card debt, or maybe you’re saving a little bit more. On top of that, maybe you’re spending a little bit less, but that’s that’s what you need to replace.

Joe: Right? I mean, this is total spitball back of the envelope, right? You could model this out even further, which we would probably recommend that you do if you want to retire at 60. But it’s you’ve saved a ton of money. I don’t even know if he has a mortgage. Maybe his mortgage gets paid off in, you know, five years as well. And so that’s another reduction of fixed income. So look at your lifestyle. What are you spending? A lot of times people will spend a little bit more in retirement too. You might want to. Travel, you might want to, you know, fix up the house, you’re going to do different things, so, you know, just kind of play with that as well.

Al: Yeah, and that’s a good point. I think a lot of times the experts say you’re going to spend less in retirement because you don’t have to commute. You don’t need to buy the good clothes. Our experience was for people that have saved money. They spend more because they have more time for leisure, more time for travel. So just keep that in mind.

Joe: Yes, because you are right on track. All right. Thanks for the question. Confused 60 year old. Hopefully, you’re not confused anymore. And go ahead. Retire. Tell your boss to go pounds sand. Got that T-shirt coming too.

Al: You do?

Joe: Yes, you got it. But it’s got to be. That’s my good career out making T-shirts.

Al: Perfect.

Are Capital Gains Taxed Progressively? (James, AZ)

Joe: James from Arizona writes in. “Joe, Al and Andi, thanks so much for your podcasts. I have a quick question. Are capital gains taxed progressively like income? Or do we pay the same tax rate on all long term capital gains after the gain amount is added on top of our adjusted gross income? I did a Roth conversion earlier in the year to take me to the top of the 24% tax bracket. With home prices skyrocketing this year, we took advantage and sold our second home for a net gain with $225,000. How will the capital gains tax be calculated on $225,000? We are married. Filing jointly taxable income after standard deduction will be $326,500 on top of 24% tax bracket, plus another $225,000. Our long term capital gains equals $551,600. Does that mean all of the $225,000 will be taxed at 20%? Thanks so much for clarifying this.” This is James again from AZ and a couple of things that James has to consider here of (A) what capital gains tax bracket is going to be in correct? And then also, is he subject to net investment income tax?

Al: Correct on both. And by the way, it is progressive, James. But we’ll explain, because many people won’t know what that means. So, if you look at your total of your your taxable income with the capital gain 551,0000. So then you compare that to where does the 20% rate start on capital gains? It’s about $50,0000 for a married couple, so about $50,000 would be taxed at 20% and the rest would be taxed at 15. But hold on here one second, because your adjusted gross income as a married couple is over $250,000, so you have to pay another 3.8% for the net investment income tax that’s on top of the 15, so it’s really 18.8% on, you know, let’s call it $175,000 roughly of capital gains and then 23.8% on about 50,000 something like that.

Joe: So to see in another way, there’s two taxes that he so he’s looking at a progressive tax. And what that means is that on ordinary income, we have multiple tax brackets. You got that 10%, 12%, what, 22, 24 and so on. Yeah. And let’s say if you fall into the 24% tax bracket, that doesn’t necessarily mean 100% of your assets are taxed at 24%. Yeah, some are taxed at 10, some are taxed at 12, some are taxed at 22 and so on. Until you reach, you know, whatever that number is that hits that bracket. Capital gains does the same thing, but there’s only really three brackets correct. There’s a 0% tax bracket, so that’s anything from to that the 10 or 12% tax bracket. Yeah. Then from there you’ve got the 15% tax bracket and then after that you’ve got the 20% tax bracket. However, you’re there is no really progressive tax on the 0%. Because you’re still going to be one depends on if it’s all capital gains or if it’s all ordinary income, he’s got ordinary income, so it doesn’t necessarily matter in this case.

Al: Yeah. So that’s a way to think about this as you sort of calculate your ordinary income first, which is what you’ve done, James. You gave that to us. The the taxable income would be about, call it $330,000 roughly. And so then you put your capital gains on top of that to figure out which capital gain rate you’re in. Well, you’re in the 15% you’re we’re well past the $80,000 top of the 12% bracket. So none of the capital gains tax. Zero. Right. But but most of it, as I mentioned, is taxed at the 15% bracket.

Joe: And then you till you reach the 20%.

Al: Which is that $500,001 to be more exact. But anyway, so that’s where you hit the 20%. But we’re just saying there’s an extra tax in there that’s completely unrelated to capital gains. It’s called net investment income tax, which you have to pay on capital gains once your adjusted gross income is over $250,000, which it already is, which means the 100% of this capital gain you’ll have to pay the 3.8 % on as well.

Joe: So hopefully that wasn’t a surprise for change.

Al: Well, I think it’s maybe it was a good answer for him because he want to make sure it was progressive, which it is. So in other words, it’s not all taxed at 20. Well, yeah, so he might if they was all taxed at 15

Joe: Well, he was thinking, OK, well, you know what, this this extra $225,000 is, is that going to be taxed at 20%? Yeah, the answer’s correct. Only a sum of $50,000 yeah of that is going to be taxed at the 20% rate. But then, of course, but it’s actually 24%, call it 24.

Al: And really, when you think about it, there’s for capital gains rates. There’s 0, there’s 15, there’s 18. We call it 19, there’s 19%, there’s 24% rounding the 23.8%, the four, that’s those are the four brackets.

Joe: All right. Hopefully, that helps. Thanks for the email.

What’s the Tax Rate on My Required Minimum Distribution? (podcast survey)

Joe: OK, we got some podcast questions that came in from our survey, and these are just like random questions.

Al: OK, go for it.

Joe: The 24% tax bracket, there are multiple buckets of taxes to be paid. OK. Yep, multiple buckets. How does one figure out, though? What does one figure out the what the after tax income will be when RMD start? Can you follow that?

Al: I think you can take the word out. It works better. So I think that they want to know what what’s the tax rate on my RMD?

Joe: What the what, what, what the what, the what, the what, what’s the tax? They’re pretty upset. It’s like what, what the what? For example, we have to pay three and a half % extra on investments. 80% of Social Security is tax. Is all of this before or after the 24% tax? OK.

Al: So yeah, what’s the tax rate on the required minimum distribution when you’re 72 and older on a retirement account? But what the what the what the what is the after tax income will be? OK, so he’s looking at he’s got RMDs, he needs to know or she knows or whoever this person is, what will rate, what can extend? What’s my tax rate? I have no idea.

Joe: So how did the tax work? Yeah. So he’s thinking he gets an 80% or she’s still going to get some 80% tax on Social Security now. Is that true now, right?

Al: So 0, 50 or 85? But you’re close, 85% of Social Security can be taxable. That 85% tax

Joe: 75% or 85%

Al: 85 15

Joe: 15. Huh? Some people 75, 85 95. Why the hell did I get confused on that?

Al: I don’t know. Zero, 50 and 85. You know your IRA now you’re questioning me, and now I’m questioning myself.

Joe: I know. I mean, look at look at your chart there. Yeah, I don’t know why you think it’s everything. I don’t remember how I was thinking it’s early in the morning. Anyways, let me ask, though 85 % of your Social Security is subject to tax, correct?

Al: That’s right. Oh my God. I just don’t know.

Joe: OK, so 85 % of your Social Security is going to be so it could be 82. It depends on the formula

Al: It can. You could write it said save yourself.

Joe: I know it’s 50 % to 35 %, depending on the graduate.

Al: It is a graduated schedule, but I think if you’re looking at your required minimum distributions, think of that as extra income over what you already have. So you’ve got to go to your marginal bracket if you’re already in the 24% bracket. If you add more income, it’s going to be taxed at 24% if you’re already subject to the 3.5% tax or 3.8%, actually, to be exact. That’s the best way to get the law changed, so the 3.8 % net come tax is not taxed on required minimum distributions, but it might push your other income tax income higher to wear more of your dividends are taxed. So you kind of if you want to know exactly get TurboTax put put the required minimum distribution in with and without and see what the extra taxes, but quick answers go to your marginal tax rate. That’s the tax you’re going to pay.

Did you catch it when Big Al said “look at your chart, there” to Joe? That’s because the fellas do not know all all these ranges and limits and rules off the top of their heads, and you don’t have to either. Get yourself a copy of the 2021 Key Financial Data Guide from the podcast show notes at YourMoneyYourWealth.com and use the exact same guide the Joe and Big Al use. See at a glance the 2021 brackets and capital gains tax rates, retirement plan contribution limits, taxation on Social Security, Medicare premiums, and more credits, deductions, exemptions, distributions, exclusions than you can shake a stick at. Click the link in the description of today’s episode in your favorite podcast app to download the 2021 Key Financial Data Guide for free.

Should We Keep Our Indexed Universal Life Insurance Policy? (Em, Florida)

Joe: We got, “Joe and Big Al I’m Em from Sunny Florida. I drink champagne.” Wow, that might be a first for our show. Champagne. “I drive a Pontiac G6 convertible circa 2007.”

Al: Yeah, that looks pretty nice.

Joe: Yeah, it looks like I’m Floridian for sure. Oh, champagne.

Al: Yeah, I wonder if it’s red?

Joe: I don’t know. “That no longer converts.” Oh well, that’s too bad.

Andi: Wrong show.

Joe: Yeah. Oh, look at that. But I’m bummed. “I have a striped house cat. I turned 40 this year and I realized I had to grow up and get serious by investing. Married with two kids under five, gross annual income over a million. Effective tax rate over 30%.

But happy not to pay state income tax.” Well, congratulations. All right. “My husband has held the financial reins for most of our marriage. He believes we will always be in the highest tax bracket in that capital gains tax rates will continue to rise and someday equal normal income tax rates. He doesn’t want to put a ton of money into a taxable account, so we purchased IUL policies that combined cost $300,000 a year.
We are now in year 7 into a 30 year term. A combined surrender value is currently $2 million. We were sold these by a family member and my husband is adamant on keeping them.” The the plot thickens.

Al: Yeah, don’t make the husband mad.

Joe: “ We have $750,000 in what we have converted all of our retirement Roth. We have a million dollars in a taxable account. 50,000 His business invests 100,000, excuse me, 500,000. When, say, 50 50. Excuse me, Mr. Cicero. $500,000. His business investment. He is a W-2 employee with private equity investment. We had $600,000 in 529 plans, $33,000 in the HSA and $25,000 in real estate. We maxed out 401(k) backdoor Roth, and each year her husband will at some point inherit over a million dollars from same family member that sold the IUI.

AL: Oh, so you’ve got to be careful there. I wonder.

Joe: I don’t know. I think there’s mom or dad that can be the spouse only bring a spouse only buys single stocks and bitcoin equivalents.

Al: But does that mean that, Em, I guess the spouse.

Joe: Em’s husband, but 70 % of the portfolio, I’ve added index funds to the portfolio, 30% of the portfolio in the last two years in minimal real estate. We have no bond funds only stocks in Roth and taxable. My attempt at financial literacy has caused marital stress. I’m uncertain where to direct the money going forward. IUL will likely stay hub says think of IUL is a giant bond fund guaranteed returns less volatility. Do you think keeping this giant IUL in treating it as a giant bond fund, moving forward with a more reasonable bond index fund, 90% or more stock portfolio is a reasonable thing to plan how much to invest early outside of this IUL stay on track.

Andi: Yearly.

Joe: OK, thank you. Should we add bonds at some point? Do we keep putting all retirement in Roth if possible, with these tax changes, that’s on their big 529 plan? Can we transfer not change beneficiary on account to a nephew and ask them to pay us some of the money. Thoughts on penalty withdrawals later? Random tidbits would like to retire early. $700,000, I don’t know. You all are hilarious and sometimes helpful.

Al: Sometimes the operative word said, occasionally yes.

Joe: Thanks for that. Are you interested in buying my convertible? It’s a hard top. No spam. Please have a great day. No spam. When are we going to spam her?

Andi: No idea what she’s talking about, do you?

Al: Oh, it won’t work because they like spam.

Joe: She doesn’t want us to send all kinds of emails to her. Well, maybe I have a spam sandwich that I enjoy eating and you can convert that to? Yeah. Got it. OK. What the hell is going on here? So M’s Husband is related to a Northwestern Mutual insurance salesman.

Al: That’s a guess, but that could be a good guess. So what’s what’s the IUL?

Joe: Index Universal Life insurance

Al: Starts there, right?

Joe: And so why people invest in the index or why it’s sold? Is this is that in Indexed Universal Life policy is that your purchasing life insurance and its after tax dollars that is going into a life insurance contract, right?

Al: Yep.

Joe: The cash value of the life insurance contract is growing tax deferred. You don’t pay any tax on any of the growth within the life insurance contract. When you pull the money out of the contract, it’s fine for tax treatment, first in, first out. So you’re taking your bases out of the contract. There is no taxes in then any of the growth that happened within the contract you take out as a loan. So the IRS says, OK, well, they don’t classify a loan is a taxable event. And so you’re taking a loan from yourself in your then taking money out in your growing it tax free. The husband is saying tax rates are going to go sky high. Capital gains rates are going to be the same as ordinary income rates and we’re going to lose half of our assets to tax and so let’s jam all of this into an annual policy. And so the family member, you know, that has thousands of trophies and trips from whatever mutual fund or whatever, which life insurance company, this individual works that sells Salesman of the Year. Troops that are selling this policy on this kid, but a million dollar policy a year, just to jam, $300,000 into it. So on the surface, does this make sense? OK, well, it depends. Indexed Universal Life and versus whole life is two different things. Let’s see if it’s whole life. You get a guaranteed rate of return in Indexed Universal Life is kind of like the best kind of the index annuities where, (A) it’s it’s a fixed rate, but they’re buying call options on their general account and you could exceed a little bit more, but you’re never going to lose money and blah blah blah blah blah. And so if he’s buying that thinking is going to get stock market like returns with no risk, that’s going to come out tax free. That’s not the case here.

Al: It doesn’t happen.

Joe: Does he need the life insurance? Well, sure, he needs some life insurance that got two small kids right?

Al: And he’s making a lot of income.

Joe: And both of them have a million dollars of income combined. And so she’s now listening to our podcast and probably some others. And so she’s having some marital stress because she wants to do things a little bit more fundamentals. Let’s buy broad based diversified index fund, low cost tax, manage it. And he’s like, No, we’re going individual securities, bitcoin and IUL? I would have been able to stress till I was going to divorce my wife. Well, your ex-wife would be like this. It would be over.

Al: It’s yeah. So it’s not what we would recommend, but this is what is there anything good about this? So we can we can preserve or make a ton of cash.

Joe: I mean it’s a ton of cash, I mean, God bless it. I mean, they got $2 million in this. So you know, the problem is, is that most people don’t fund these policies correctly. Right? So they get sold this bag of goods that, hey, this is going to grow tax deferred. And then there’s a corridor within the overall life insurance policy. And as long as you maintain that and don’t create a Mac, you can create a tax free account. I don’t know if he’s creating a modified endowment contract or not. He could be. And then it’s kind of formed as an annuity.

Al: It does seem like a lot of money going in.

Joe: $300,000 a year might be like a $5 million for somebody this young, right?

Al: Well, let’s see. She turned 40. How about him by a similar age? Well, yeah. Well, some 40. Yeah, so that’s yeah, modified endowment contract if you put too much money into these. In other words, the IRS doesn’t want you to have too big of a savings account when it when it relates this kind of life insurance policies, and it can mess up the whole thing.

Joe: So unless you design it that way, which I don’t think they did, so I’m not a fan IUL whatsoever if, let’s say, if this was a reputable, let’s say, Northwestern Mutual and it’s a whole life policy? You know, you probably got a pretty good fixed rate of return at a relatively low cost. But IUL, I can’t stand. I think it’s sold, but the way it is funding it?

I’m guessing here, but you have very little flexibility. So when you want to start taking some of this money out, right? And then so are you going to reduce the death benefit? What type of policies? I mean, is it multiple policies? It sounds like. How are you investing within the overall policy? It’s just a pain in the ass. If it because it’s after tax and they’re trying to grow this money, tax deferred and then tax free. Right. So some people call this thing the giant Roth, which is almost illegal to even think about. I think today, if you tax manage a non-qualifying account appropriately, you can control the taxes not as good as tax free, but almost.

Because there’s tax lost harvesting opportunities, if you could control the taxes, you could go very low in expenses. You could go very low in turnover. That’s going to keep a lot of extra income up your tax return. If you think that capital gains rate is going to turn into ordinary income, I don’t know. That’s kind of a far fetched, but it could happen. I mean, if you make over $1 million a year, Biden said that that he would discuss. And so he might be freaking out because of that. But he’s 40. And so he’s putting this much money into kind of an in my opinion and other life insurance lovers are going to come out and blow me up. But I hate the strategy. I just think you’ve got too many hoops. I think he could do it better, easier, with a lot less expense because he’s still there’s so much expense in these policies and you still have a cost of insurance so that cost of insurance, as he ages, is going to continue to increase. Right? And so as he’s taking money out, he has to keep these policies in force for the rest of his life.

And maybe that’s fine. And maybe that’s his plan. And maybe it’s a legacy plan for his kids and so on. It sounds like they’re very successful, but I don’t know. I would much rather have $2 million in a brokerage account than $2 million in an IUL.

Al: Well, I would, too. And I don’t know as much about these plans as you do that, you know, to me, the downsides are that there’s a lot of internal costs. The rate of return over the long term is probably not going to be that great because you’re paying for that downside protection. In other words, if you’re in the more in the market, yeah, you’re going to go up and down. But if you if you sort of straight line over 30, 40 years, you actually do much better being in the market than trying to be in something like this. To get the money out can be tricky. Some of that’s return of capital, some of that is tax free. But you’re right, and this is what happens. Maybe not in this case because they got so much money in it. But in many cases, what happens is people take out the tax free loans and the cost of insurance by the time in their 70s and 80s goes very high. They can’t afford the premiums. The thing fails. All of a sudden, all this tax free loans are fully taxable and they got no money to pay the tax. But that’s a danger. Now in this particular case, maybe there’s so much money in and maybe they make so much money. They can avoid that, but it’s still a huge concern of mine.

Joe: Right. I mean, if they make a million dollars, they’re putting 30% of their income right into a life insurance contract.

Al: Yeah, and that’s 30% before tax and not getting a tax, right?

Joe: So it’s half, yeah.

Al: Right, they’re putting about half of their half of the income.

Joe: Let’s see that, honey. We’re putting half, you know, a life insurance policy. Does that sound right? Right?

Al: You know, I don’t know. Right.

Joe: But I get it. I mean, he’s got strong beliefs that, you know, crypto, tax is going to go through the roof. Everyone, you know?

Al: Yeah. But let’s give her a little bit to chew on because I’m sure she wants to save her marriage. So there is downside protection. Right? So that’s a good thing.

Joe: It’s tax free. You got down. I mean, right. If he wants to call it a bond, you could call it a bond and totally fine with that because it’s going to get anywhere from, let’s call it, 1%-4% rate of return. The money is in a life insurance contract, so I don’t know the life insurance, but you’re stuck with the contract. The life insurance companies could do anything they want in some cases, right? Is it subject to change? What are the credit methods on the money?

Al: Yeah, I don’t. Well, you’re and you’re basing half of your disposable income on a single insurance.

Joe: It seems like we’re trying to see the positive effect. Sorry. All right. So it’s tax free. You can call it a bond equivalent. I’m fine with that. I think that well, as long as you, you follow the rules appropriately, you could have tax free withdrawals.

Al: So here’s something I would say is a lot of times you get these, they call them illustrations, right? Like, how does this play out over your lifetime? And in many cases, it’s not all. In many cases, the the the agent that sold the policy makes this family member. Maybe that’s not true, but in many cases they use the rate of return. That’s unrealistic.

Joe: Sure, a lot higher rate of return.

Al: So, so make sure that you have an illustration with a conservative rate of return, because that’s probably what you’re going to get on this and see how this plays out into your 70s, 80s, even 90s. And does this still make sense for you?

Joe: Right. I think in a couple million dollars that you already have in the past, we let it grow. You’re only 40 years old. You let’s say you want to retire in the next 15, 20 years or whatever it is. Right? Maybe your new strategy is to say, hey, I think we’re good with the life insurance. Maybe we redirect the $300,000 into, you know, ETFs that are low cost, extremely tax efficient. Maybe we look at direct indexing where you can really dive in and look at multiple ways to tax lost harvest.

Al: Yeah, sure.

Joe: There’s other investment strategies I think that he would get into if he’s just educated on them. Now, I think that the way or he has certain beliefs, right? It sounds like he has certain believes that he doesn’t believe in the federal government playing nice in taxes or that, you know, cryptocurrencies is the wave of the future.

Al: And that’s probably how his family is. And that’s who sold him the policy.

Joe: Sure. And that’s totally fine. And I think diversification in crypto in that is fine. But I don’t know. You just want to have a little bit of balance, and I think she’s doing a good job of trying to bring that balance into play. And I wish him all the luck. Yeah. Keep drinking that champagne, girl. Appreciate everyone’s questions this week. Hopefully, we answered them all to your satisfaction. And yeah, I think that’s it for us. We will see you again next week. This show’s called Your Money, Your Wealth. Go to yourmoneyyourwealth.com. Click on Ask Joe and Al. That’s where you ask your questions and we’ll get back at it.

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Kicking yourself, dancing with the YMYW dance crew, Prior Fairy, and the Retirement Readiness guide in the big ol’ Derails at the end of the episode, so stick around. 

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