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High savings + pension = High taxes

by smeneshi - Mar 30, 2017

Anyone with a good pension and a large 457, 403b, TSP or IRA account balance has a tax problem.That’s because a number of factors usually converge for public sector retirees during retirement that may result in a heavy and ongoing tax burden. The combination of a high pension income, required minimum distributions, Social Security benefits, a spouse’s income, or income from another job or business and very few tax deductions may keep you in the same, if not elevated, tax bracket. Ironically, during retirement you may be earning the same or possibly more income than during your peak earning years. When you combine this possibility with the probability that you may have very little in the way of tax deductions, you may be paying Uncle Sam way more income taxes than you anticipated. Fortunately, with enough foresight and proper structuring, you can avoid the tax shock that many of you may inevitably have to contend with in the future.

Years ago, I wrote a cautionary article about the drawbacks of “over-contributing” to a 457, 403b, or TSP, warning the day may come when you could be paying more in taxes during your retirement years than when you were employed. Anticipating that you may have a hefty tax burden during retirement, how can you offset or reduce potential tax obligations? There are a few ways, but the one that will be outlined in this post revolves around the funding of a properly structured life insurance policy.


It’s not about the death benefit anymore


For most people, the first exposure to life insurance comes in their 20s or 30s as many begin to raise a family. Life insurance during this stage in life is absolutely vital as a wealth-replacement tool should one or both parents pass away. The death benefit will help the survivors get the care and education that would have otherwise been provided by the deceased parent’s income. As a younger person, the main consideration when buying a life insurance policy is the creation of wealth at death. As you get closer to retirement, life insurance should be considered as a way to to protect your wealth while you’re living.  For example, when designed properly, life insurance can protect your estate from long-term care expenses by transforming the death benefit into a living benefit. Additionally, when the right type of insurance policy is put into place, you can benefit from tax-deferred growth linked to gains in a market or markets without the risk of loss, tax-free distributions of your principal, and tax-free loans that can supplement your income. In other words, there are major benefits built into the policy that can be leveraged during your lifetime – not just at death. When you pass away, a tax-free death benefit will be paid to your beneficiary or beneficiaries, and if it’s been planned the right way, the policy proceeds will replace all of the wealth you lost to taxes. If you have intentions of helping your local charity, church or synagogue, an insurance policy can help those institutions as well.


Retirees With a High Pension Can Benefit the Most


High income earners oftentimes max-out contributions to tax-deferred savings plans such as a 457, 403b, or TSP; IRS-imposed income limitations may prevent contributions to a Roth IRA. At this time, a higher degree of financial planning should be considered since a number of factors may provide the perfect opportunity to:

  • Save more for retirement
  • Reduce income taxes
  • Protect against long-term care expenses
  • Provide tax-free retirement income
  • Leave a tax-free legacy for your family

For example, for savers that have maxed out their retirement accounts, an indexed universal life insurance (IUL) policy may provide the perfect combination of tax-deferred growth, income tax-free distributions, income tax-free loan proceeds, long-term care protection, and tax-free death benefits. That’s because when distributions of your accumulated cash value are withdrawn from your policy up to the amount you contributed, the withdrawals are not considered taxable income, as opposed to most withdrawals from 457, 403b, TSPs and Traditional IRAs.

Perhaps the most efficient way to make withdrawals from your retirement plan is to take a loan against the value of your policy instead of a withdrawal. Unless classified as a modified endowment contract, or MEC, policy loans are usually not subject to income taxes since a loan is not considered a source of income. When set up the right way, the loan is never required to be paid back while you’re living, though you will have to pay interest on the loan. However, the potential growth in the cash value of your policy could be enough to offset the interest being charged, hypothetically resulting in a wash.   Of course, you have to tread carefully with this strategy because loans and withdrawals will reduce the cash value and death benefit of your policy and if you’re not careful, your policy could even lapse or affect guarantees against lapse; additional payments may be required to keep the policy in force.

While the tax advantages of life insurance policies have been around for a long time, and when set up the right way can mean tax savings of tens of thousands to hundreds of thousands of dollars, funding the right type of policy that fits your specific situation can be a complex undertaking.  Therefore, it’s best to consult with a professional who has a high degree of competency in this area. Because of the major tax savings potential of this strategy, along with possible pitfalls if not properly structured, PRP will be releasing a comprehensive whitepaper sometime this year that explains this strategy in more detail.


Consult with your tax advisor prior to applying tax strategies. Securities and advisory services offered through Ausdal Financial Partners, Inc.  Member FINRA/SIPC 5187 Utica Ridge Road Davenport, IA 52807    563-326-2064  Public Retirement Planners, LLC and Ausdal Financial Partners, Inc. are separately owned and operated.


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