SHOREVIEWSM Zero-Tax Planning

One basic idea of zero-tax planning is to pay tax on a relatively small amount now in order to pay zero tax on a big amount later. Another basic idea is to decrease the amount of taxable income so that the taxpayer is in a low or zero income-tax bracket. This aspect could be valuable if income-tax rates rise dramatically in the future, as many are currently predicting. Zero-tax planning for some individuals and families includes irrevocable life insurance trusts.

A key tool for implementing zero-tax plans is life insurance. For taxpayers expecting total retirement income of about $40K or more as an individual, or about $80K or more as a married couple, SHOREVIEWSM Zero-Tax Planning using life insurance might be worth considering.

Life insurance is a highly efficient, but under-utilized investment vehicle for building wealth. Under the U.S. tax code, cash value within a life insurance policy grows tax-free, and death benefits are distributed income-tax free to beneficiaries.

Further, loans and living benefits (e.g., benefits paid under long-term care and critical illness riders) are received tax-free by the policy owner. Of course, the death benefit received by a beneficiary in case of an untimely death of the insured should not be overlooked when considering life insurance as an investment.

It is well known that a life insurance policy carries costs. The cost of death-benefit insurance is an obvious cost. As the age of the insured goes up, the cost of insurance per dollar of “amount at risk” increases, but in a well-designed policy, the amount at risk decreases, so the total cost of insurance actually goes down. Additional policy charges include administrative and sales costs. Nevertheless, costs in a well-designed life insurance policy are less than the management fees and internal costs of many investment and retirement accounts.

For investment purposes, an Indexed Universal Life (IUL) policy is typically the policy of choice. Other types of policies (e.g., Whole Life or Guaranteed Universal Life (GUL)) may play a role in financial and estate planning, but for zero-tax retirement planning, IUL is the default option. IUL can be characterized as having controlled risk, flexibility, and good potential for cash-value growth, as presented in detail throughout this website.

IUL does not have the numerous limitations of Roth IRA accounts, that is, liquidity restrictions, contribution limits, and RMDs for both owner and beneficiaries.

When IUL is used primarily as an investment vehicle to generate tax-free growth and income, rather than to provide a death benefit, the policy owner need not be the policy insured. Instead, an older policy owner can insure a younger family member, such as a child, sibling, niece or nephew. Having a younger insured generally lowers cost of insurance and thereby increases the policy’s rate of return.

Option A:  Zero-Tax Retirement

An individual or couple planning for retirement typically has some combination of three general categories of investments as retirement income sources; taxable, tax-deferred and tax-free. Common examples include:




Capital gains

1099 dividend and interest from stocks, mutual funds, CDs

Social Security maybe?








Roth IRA

Roth 401(k)

Life insurance

Social Security maybe?

With the right early planning, zero tax (or close to it) retirement income is achievable. It is done primarily by investing post-tax funds in tax-free investment vehicles and by shifting investment amounts already in the Taxable and Tax-Deferred columns to the Tax-Free column.

Employer Matching-Contribution Plans. The sound conventional wisdom is that an employee should always try to make pre-tax contributions to a qualified retirement plan (401(k), 403(b), etc.) up to the maximum amount of any employer contribution-matching. The matching employer contributions are effectively free money.

Phased Conversions. If funds are converted or rolled over from Tax-Deferred to Tax-Free accounts, income tax is due on the converted amount. Conversion amounts should be limited to avoid pushing the taxpayer into a high income-tax bracket. For example, if a 401(k) account contains $500K, then phased conversions of, let’s say, $50K annually could avoid moving into a much higher tax bracket.

Backdoor IRA. A backdoor Roth is a conversion of Tax-Deferred IRA assets to a Tax-Free Roth IRA. Currently, anyone can convert money that they have put into a traditional IRA to a Roth IRA, no matter how much income they earn. Further, there are no limits to the amount of money being converted from existing Tax-Deferred IRAs into a Roth IRA. This technique can also be applied to funds in qualified retirement plans, such as 401(k) and 403(b) plans.

Rule 72t. The so-called IRS Rule 72t exception allows penalty-free withdrawal of funds before age 59½ from IRAs and employee retirement accounts (e.g., 401(k), 403(b) plans) using separate equal periodic payments (SEPPs) until age 59½. The usual income tax must be paid on Rule 72t distributions, but then the distributed funds can be invested long-term in life insurance (typically IUL).

Time Horizons. The transfer of tax-deferred funds (e.g., IRAs, 401(k)) to tax-free investments (Roth IRAs and IUL) generally does not make economic sense over short time horizons (because of income tax paid upon transfer). When time horizons exceed 5 years or so, it starts to make sense, depending on current and future tax rates, as well as actual average rates of return.

IRS Contribution Limits. Except for a Backdoor Roth IRA conversion, investment of post-tax funds in a Roth IRA is restricted to income earners with income limitations and maximum contribution amounts ($6,000 to $7,000 in 2019). Also, If an employer plan allows it, an employed individual can contribute up $19,000 ($25,000 if age 50 or older) into a Roth 401(k) account. This limit applies to the total of 401(k) and Roth 401(k) contributions. In any case, Roth plans have liquidity limitations, and Roth 401(k) accounts are subject to RMDs (required minimum distributions) starting at age 70½ (currently under consideration to be raised).

Liquidity and distribution limitations of Roth IRAs. The original owner of a Roth IRA may not take distributions tax-free until the Roth IRA has been in existence for at least five years and the owner has reached age 59½. Although the original owner of a Roth IRA has no RMDs, both traditional Tax-Deferred IRAs and Roth IRAs inherited by a spouse or non-spouse beneficiary are subject to liquidity and distribution limitations. If the Roth IRA has been open less than five years, earnings are taxable. A non-spouse beneficiary must take RMDs, based on either a lifetime or 5-year formula.

Indexed Universal Life Insurance (IUL). IUL does not have contribution limits or RMDs. Unlimited amounts of post-tax funds from Taxable and Tax-Deferred accounts can be moved to IUL (upon payment of any income and capital gains taxes incurred) and can be used to grow wealth tax-free and provide tax-free income. Tax-free income avoids moving a taxpayer into a higher tax bracket. IUL is well-suited for ownership by a trust, which can provide asset protection, as well as efficient management of IUL benefits.

Provisional Income and Social Security Taxation. Tax-free income also avoids raising “provisional income”, that is, the income used to determine whether Social Security income is taxed or not. Basically, “provisional income” is the sum of adjusted gross income, non-taxable interest income, and one-half of Social Security (SS) income. For a single person with provisional income below $25K in 2019, no income tax is applied to SS benefits; with provisional income between $25 K and $34K, up to 50% of benefits are taxed; and above $34K provisional income, up to 85% of SS income is taxed. For a married couple with provisional income below $32K in 2019, no income tax is applied to SS benefits; with provisional income between $32 K and $44K, up to 50% of benefits are taxed; and above $44K provisional income, up to 85% of SS income is taxed.

Medicare Means Testing. Income from Taxable and Tax-Deferred accounts increases modified adjusted gross income (MAGI), which is used by the Social Security Administration to calculate Medicare premium surcharges. Minimizing MAGI by shifting income sources to Tax-Free minimizes Medicare premiums.

Standard Deduction Lowers Tax Bracket. For tax year 2019, the single-filer standard deduction is $12,200; for married persons filing jointly, the deduction is $24,400; for head of household, $18,350. If the total of Taxable and Tax-Deferred income is less than the standard deduction, then a 0% tax bracket is achieved. If Taxable and Tax-Deferred income is greater than the standard deduction, then a 0% tax bracket is impossible, but with advanced zero-tax planning, income tax can at least be minimized.

Implementing a Zero-Tax Retirement Strategy. The zero-tax strategy entails being guided by the facts outlined above to invest funds in Tax-Free accounts (i.e., IUL and Roth accounts) to generate retirement income that is mostly tax-free, within the expected standard-deduction amount. For example, if the total annual retirement income from all sources is $100K, and if the standard deduction amount is $24K, then if the Tax-Free portion is $76K or more, zero tax will be owed on $100K. Even if the standard deduction is less than the sum of Taxable and Tax-Deferred portions subject to taxation, if the provisional income is less than the cut-off amounts, then all or half of Social Security will be tax-free. The time to implement a zero-tax strategy is as long as possible before retirement income will be taken; in other words, soon. The longer time assets grow undisturbed in Tax-Free accounts, the more tax-free income will be available. Income tax rates are currently at historically low levels. That suggests paying relatively low taxes now to put post-tax funds into Tax-Free assets. Of course, the exemplary numbers used here are subject to changes due to expected annual inflation adjustments and, more importantly, subject to changes in tax laws and tax rates.

Option B:  Zero-Tax Legacy and Asset Protection for You and Your Descendants, Forever

An advanced planning structure, the life insurance dynasty trust, enables wealthier individuals and families to grow post-tax funds tax-free and to distribute wealth tax-free for many generations, or perpetually.

Irrevocable Life Insurance Dynasty Trust. A dynasty trust, also known as a GST, legacy or perpetual trust, is a flexible vehicle that can provide asset protection, wealth management and wealth accumulation for many generations, or even perpetually. In making contributions to a dynasty trust, an individual’s (or married couple’s) exemptions for gift taxes and generation-skipping transfer (GST) taxes are utilized to insulate trust assets and distributions against gift and estate taxes forever — a good way to protect family businesses and hard-earned family wealth against punitive taxes, divorce and frivolous lawsuits. When trust assets are invested in a life insurance policy, no income or capital gains taxes are paid on investment growth, and insurance proceeds pass income-tax free to the trust. Accordingly, trust assets invested in life insurance can grow and be distributed to beneficiaries completely free of taxes perpetually. As net policy proceeds are paid tax-free to the trust upon death of the insured, the trustee of the trust uses some or all the proceeds to buy a new life insurance policy on the life of a young beneficiary, and the cycle is repeated, indefinitely. A dynasty trust enables the grantor(s) to make a gift of financial security to future generations, to pass on family values, and to protect trust assets against creditors. A dynasty trust can be drafted to implement the wishes of the grantor(s), while also giving the trustee(s) discretion and flexibility to adapt to changing legal, tax and family circumstances. An offshore trust may provide extra asset protection and investment options (e.g., offshore private placement life insurance (PPLI)). A domestic structure holding IUL, however, is usually well-suited for most purposes. Depending on circumstances, a life insurance dynasty trust can make economic sense for an individual or couple having a net worth of about $1 million or more.