Many people understand the benefits of diversifying investments among asset classes to help manage the risk and return of a retirement plan. But diversification can also be used to help manage the tax treatment of retirement assets—resulting in the potential for higher net income during retirement years.
Example of Tax Issue
PROBLEM: 401(k) withdrawals are taxed as ordinary income 
In addition to some rental properties and his Social Security, Brian’s retirement plan consists only of his 401(k) plans. He has maximized his contributions and has a tidy sum saved. His financial professional (FP) points out that withdrawals from his 401(k) accounts will be taxed as ordinary income. His FP also explains that Brian may be in a higher tax bracket during retirement than he is now– due to possible changes in tax law and his growing account values. At retirement, assuming a 25% tax rate, an annual withdrawal of $100,000 would result in taxes of $25,000, leaving a net income of $75,000 available for his retirement.4 They discuss tax diversification as an option and that having some tax-free income would increase the amount available.
SOLUTION: Cash value life insurance such as Indexed Universal Life Policy can help provide tax diversification.
Working with his FP, Brian has also decided that he needs $1 million of life insurance to protect the family. The FP shows Brian how a cash value life insurance policy can help him meet both objectives – life insurance protection for his family and a ‘taxed never’ asset to increase his diversification.
RESULTS: At retirement, Brian choose to take $50,000 from his 401(k) and from his cash value life policy. He was able to increase his net income by $12,500 over the 401(k)-only plan.
- The descriptions and features of the various assets in these tables are for general information purposes and address the most typical circumstances. There are many regulations governing the taxation and operation of all assets mentioned and you should seek the advice of a tax professional before making any changes to your current or future retirement plans, accounts or assets.
- Cash value life insurance policies are subject to Modified Endowment Contract rules that discourage overfunding based on face amount, insured’s age and other factors. Cash value life insurance also contains additional mortality charges that will increase the expense of this product. Also, distributions in excess of total premiums paid are taxable unless taken as loans (which are subject to interest charges). Consult a policy illustration for more information.
- This is a not an actual case. It is a hypothetical representation for illustrative purposes, only. The individual 401(k) plan and life insurance policy withdrawals are aggregated in the illustration for convenience. It is not a comprehensive analysis of the subject matter and you should work with a tax professional before making changes to your circumstances.
- Withdrawals are subject to federal tax of 25% and may be subject to state income taxes. A 10% federal early withdrawal tax penalty may apply if taken before age 59 1/2.
- Withdrawals in excess of total premiums paid are taxable unless taken as loans (which are subject to interest charges).
Investment advisory services offered through Allmerits Asset Management, LLC, a Registered Investment Adviser firm. Allmerits Asset Management does not provide legal or tax advice. Investment Adviser Representatives of Allmerits Asset Management may only conduct business with residents of the states and jurisdictions in which they are properly registered or exempt from registration requirements. Insurance and Annuity products are sold separately through Allmerits Financial and Insurance Service. Securities transactions for Allmerits Asset Management clients are through Trust Company of America, TD Ameritrade, Nationwide, John Hancock and American Funds.