High-income professionals like our physician clients have distinctive challenges to deal with when planning and saving for retirement. Most of our physician clients express their intent to live a lifestyle similar to the lifestyle they enjoyed when their practices started flourishing and the loans that were required to establish their practice were finally paid off.
There are several tax-deferred investment vehicles that can be used to develop a robust retirement income other than selling a practice that has been built over two or three decades or more. And, it makes better and safer financial sense to accumulate retirement funds over the life of your practice rather than waiting for retirement to be around the corner and then putting a for sale sign on your office.
The most apparent challenge that a physician faces if they are considering a SEP IRA, Solo 401k, or UNI 401k, is the limit placed on contributions in any given year. Here, we’ll discuss Indexed Universal Life Insurance for physicians and why it may a better option for retirement planning.
How Your Indexed Universal Life Insurance Works
First of all, it’s important to understand that although an IUL is a life insurance product, your purpose for using it is to accumulate money through interest crediting on a tax-deferred basis. The excess premium you pay into your policy is placed in a sub-account that earns interest that’s based on an index, such as the NASDAQ or S&P 500. IULs are not as volatile as variable insurance policies because your money is not actually invested in equities, but instead, the insurance company mimics the returns of the index.
Although the insurance company will place a “cap” on the amount of interest your account will be credited, it also places a “floor” which is a guaranteed return. So then, if your “cap” is 14% but the index gains 20%, your account will only be credited 14%. On the other hand, if the index has a loss, your account will be credited at the “floor” amount and your account will not lose money in the transaction.
Here is an example of S&P500 Returns with Cap of 12% and a Floor of 2%:
Year Return Excluding Dividends IUL Return 2010 12.64% 12.00% 2011 0.00% 2.00% 2012 13.29% 12.00% 2013 29.6% 12.00%
For the period mentioned above, the S&P500 return excluding dividends averaged 13.88% but the insurance policy was credited 12%. In 2011 when there was a zero return, the policy still earned 2%.
Knowing what your earnings “cap and floor” in advance should be critical to your risk tolerance. With the IUL as part of your retirement planning portfolio, physicians can take advantage of the earnings that are provided during positive earning returns without suffering the downside of the marketplace.
Certainly, administrative and management fees can have an impact on your earnings but you can be provided with that information from your insurance professional in advance so there is no blindsiding involved when you elect to purchase your policy.
Here are the benefits for physicians to consider an Indexed Universal Life insurance policy as a retirement planning vehicle rather than or in addition to traditional retirement products.
Annual Contribution Limits
The obvious response to tax-deferred investment products with contribution limits like those listed above is Indexed Universal Life Insurance. Knowing that a successful physician’s income is generally higher than many other professionals, and would be limited to making contributions of $55,000, the IUL is the better choice since there are no annual contribution limits. The contributions are made with after tax dollars, your account grows tax free and distributions can be taken income tax free.
It’s also important to note that if you organized as an S Corporation, you have the ability to make your contributions as a draw against the expected profits of your S Corp and then be able to avoid the self-employment and social security tax on those contributions and end up with a tax savings of over 13%.
A C-Corp on the other hand has even more tax advantages when using an Executive Bonus Arrangement.
Interest-Free Business Loans
The cash in your IUL that has accumulated over time is the perfect option for business loans if you need to purchases new equipment, expand your practice, or carry you through periods when your cash flow has been impacted for various reasons. Unlike other types of investment products, your cash account continues to earn interest because the account is used as collateral held by the insurance company making the loan. Your loan comes from the company, not your cash account.
Locked-in Earnings and Annual Reset
For investors who are concerned about their account security, the IUL policy locks in the earnings each year you so that your gains will be safe and secure along with your cash value total. The annual reset, which may seem innocuous to some policyholders, is actually a pretty big deal. The annual reset means that you are starting each new year at zero and there is no deficit that needs to be overcome.
As an example, from 1937 through 2015, the S&P500 experienced two periods where the index lost money three for three consecutive years: 1939 to 1941 and 2000 to 2002. The index also had one period when it lost money for two consecutive years: 1973 and 1974. In an IUL, those losses would not have had an impact on a policyholder’s cash value as long as the floor rate was greater than zero. All of the IUL policies that we offer have an annual reset and a zero percent floor.
No Required Minimum Distributions to Worry About
With an IUL our physician clients do not have to be concerned about required minimum distributions (RMDs) when they are ready to retire. With other investment products like the 401(k) or IRA, the physician would be required to begin taking distributions when they turn 70 ½ which allows the IRS to begin taxing those withdrawals. The IRS will receive their tax dollars owed to them one way or another. Many of our physician clients that have saved for years in IRAs or 401ks or 403bs are exploring IRA to IUL conversions.
The RMD is still mandatory even if you are still working and would prefer not to begin taking withdrawals from your retirement account.
Your IUL will not Impact Your Social Security
With an IRA, it is possible that your distributions could put you over the earning limits set by Social Security and result in a reduction of your Social Security retirement benefit. Not so with an IUL. Since you are taking loans against your IUL’s cash value which are not considered income, there’s no need to worry about an impact on your Social Security benefit. In this situation, your savings could be substantial.
Don’t Forget the Death Benefit
Last but certainly not least is the death benefit provided by your Indexed Universal Life Insurance. Even if you selected the minimum amount possible, you will be able to leave money for surviving loved ones after the insurer pays off your outstanding loans.
For physicians who might feel constrained if they used traditional retirement planning vehicles, an IUL is a solid alternative that can provide additional benefits to the physician planning for retirement. Having the ability to invest vicariously in the market and enjoy those benefits without fear of loss, goes a long way in making the IUL your primary choice for retirement planning.