Borrow Your Money to Pay for Contributions to Increase Your Tax Free Withdrawals 39% per Year to Age 100
We are going to compare two products. One is a pretty much vanilla standard equity account found in just about anyone’s portfolio. The other one started its life as ordinary and has been modified for growth and tax-free income. The equity account will get an assumed 8.00% growth every year, income taxed at 28%, composite capital gains tax rate at 18.90%, portfolio turnover of 25% and 0% management fee and no other costs. The other product is life insurance and has no maximum cash contribution as long as we obey the IRS code rules and the death benefit will be set at the very minimum. We will call this the balanced growth account or BGA. The BGA will get an assumed 6.33% growth every year, income tax is 0%, capital gains tax is 0%, no portfolio turnover and all fees and
Now for contributions and withdrawals
in this example, we are planning for a 41-year-old who wants to retire at age 65 and start withdrawals. Now for the equity account, this individual will contribute $20,000 per year for the first five years. For the BGA, this individual will contribute $20,000 per year for the first five years. There will be no more contributions. At age 65 withdrawals from these plans start. The withdrawals from both accounts will start at age 65. The withdrawal from the equity account starting at age 65 will be $34,491 and it will last until age 83, at that point in time there will be no more money in that account. The BGA will also produce $34,491 except withdrawals will last past age 100. Wait, it gets better.
Now for the advanced planning
Let’s go back to the BGA and take advantage of its unique properties. In the sixth year, this individual can borrow $20,000 from the account value and make another contribution to the BGA, and in the second year, this individual is going to borrow another $20,000, and make another contribution to the BGA. This will be done from the 6th year to the 10th year and no more contributions will be made. Withdrawals start at age 65 which is $48,039 and will last past age 100. This is 39% higher than it would have been without the five years of arbitrage borrowing.
Objections, why wouldn’t you do this?
#1 “It is not a deduction.” That is actually a good thing. A plan like a 401k we’ll give you a deduction, but 100% of that money is taxable and tax rates are going up. If you don’t believe that, ask 70% of the baby boomers that have not retired yet and will collect Social Security and Medicare. We can always compare a BGA to a 401k if you want.
#2 “The cost of insurance gets so high the plan will implode from increasing costs of insurance.” That sounds logical but the amount at risk for the insurance company is going down. The above example included all costs and expenses and it provided more money.
#3 “Why haven’t I heard of this.” Probably because you have not talked to a specialist in this area. It is hard to keep up outside of your area of expertise. There is a lot of information that people are not aware of.
#4 “Is the company any good?” There are a number of companies, A+ rated, over 100 years old and one of those is the world’s third-largest financial services company and has over $2 trillion in assets under management.These companies are not good, they are great and put a lot of money in research and development.
#5 “The borrowing costs are low now but they will go up and make this plan unmanageable.” Ironically, higher interest rates will be beneficial because the option budget goes up and therefore the growth or crediting increases.
#6 “What if the market crashes?” That is the reason you would want this plan. If the market goes down the worst the BGA will do in any given year is zero market loss. This is another asset class to diversify with.
#7 “… But I can get a higher rate than 8% in the market.” Maybe you can, but the destruction of capital during market declines have the greatest impact on long-term portfolio performance. Also, expenses in the above example were zero. You may also get a higher rate of return in the BGA, one of the indices averaged over 10% for the last three decades.
#8 “Who comes up with this stuff? It sounds complicated.” It is constructed and designed by actuaries, statisticians, researchers who study risk, programmers using technology to crunch numbers to identify opportunities. It is not unlike a lot of companies today. They are some of the smartest people I know and trust.
