Depending on your individual circumstances, converting your IRA to an IUL can be a very solid strategy.
You can compare this strategy to IRA or 401k to Roth conversions.
The principle is the same but the end product is different.
Although it’s not appropriate for everyone, the IRA to IUL conversion can generate tax savings over your lifetime and increase your retirement plan substantially.
There are many reasons to consider before you jump in the deep end and trigger your conversion, but here are four solid motivators to consider:
- You can take advantage of the enormous potential of indexing to grow and develop your funds safely
- Take advantage of tax-free income via policy loans
- Take advantage of access to your funds without the impact of a market value adjustment.
- Create and leave a financial legacy for your heirs above the account value.
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What Exactly is an IRA to IUL Conversion?
The IRA to IUL conversion is a procedure where you withdraw some of the funds in your IRA, pay taxes on those funds, and then use the remaining funds to purchase an Indexed Universal Life Insurance policy (IUL) to that builds significant cash value over time.
An IRA Rollover which is the process of transferring the money in one IRA account to another or a Roth Conversion, which is a process of moving money from a qualified account to a new tax-free Roth IRA account are both very similar processes.
The IRA to IUL conversion is basically different than both of these approaches but does have some similarities with each of them. Similar to the IRA rollover, the IRA to IUL conversion moves money from one investment product to another. And, similar to the Roth IRA conversion process, the IRA to IUL conversion requires paying taxes no on funds removed from a tax-deferred account and investing the net funds into a tax-free investment product (the IUL).
This strategy can be part of an overall approach to maximizing and balancing the security, growth, and tax benefits of your retirement portfolio.
Is this Considered a Sound Investment Strategy?
The answer to this question is yes, under certain conditions. Like most financial strategies, deploying an IRA to IUL conversion can be advantageous for some investors, while not the best strategy for others. Furthermore, like with any strategy using a life insurance product, it’s essential that the policy is structured properly to make certain that your financial goals are met.
It is also important to know which IUL company is the best for your situation. There are over 40 life insurance companies offering indexed UL, but I would only recommend 6 or 7 to handle the IRA to IUL conversion.
It’s worth mentioning that although some previous attempts at converting an IRA or 401k to an IUL have been considered to be controversial because in some cases the strategies were dependent upon IUL illustrations that were simply unrealistic. Suffice it to say, with any investment strategy and product, there’s a right way and a wrong way.
Knowing this, the following to qualifiers will help in the decision-making process:
- Would it be more beneficial for you to invest in a tax-deferred investment product or a tax-free investment product?
- Are you at least 59 1/2 years of age?
- Are you healthy enough to qualify for indexed universal life insurance?
- If your answer is the tax-free income option and your are healthy and older than 59 1/2, then IUL is the way for you to go.
Here is what You should Consider before Pulling the Trigger
- Since your new IUL will take time to accumulate the funds you desire, it makes good sense to use only a portion of your IRA funds when you start the conversion. Especially if you will need funds for an income stream in the next 10 years.
- Analyze Your IRA for an Informed Decision. You should consider (along with the help of your financial planner) what the tax liability will be for your IRA over your lifetime. This will help you understand if your investment strategy should be tax-deferred or tax-free.
- Compare your analysis to an IUL illustration prepared by an insurance professional. This will allow you to compare after-tax growth in an IRA with the after-tax growth in an IUL. Your insurance professional should be experienced in designing an IUL, also known as a LIRP (life insurance retirement plan) that will illustrate legitimate returns so a legitimate comparison can be made.
- Tax Liability should be handled responsibly. You are going to have some tax liability when you move some of the IRA funds to the IUL so make certain you have a strategy to accommodate the tax liability. And, do not use funds in your IUL to pay the taxes due on your IRA.
The Structure of Your IUL is Critical
The two primary elements to structuring your IUL are how it is funded and what the death benefit should be. It’s essential that your IUL is funded in the most efficient manner:
- Infuse sufficient funds into your IUL quickly in order to maximize cash accumulation.
- Do not over-pay into the IUL because it could be a risk of becoming a modified endowment contract (MEC). MEC loans are not tax-free and so you would be defeating the purpose of the conversion.
- Consider funding the IUL using a 5-pay premium plan. Using the 5-pay plan allows you to fund the IUL quickly and will help the policy from becoming a MEC. A 5-pay also lessons the impact of having to pay the taxes when you withdraw the funds from your IRA by spreading your tax liability out over 5 years.
- Selecting an appropriate death benefit is just as important as funding your IUL. Although most investors are tempted to select a minimum death benefit and forget that they can use this benefit as a legacy for the heirs or a favorite charity. The good news is that you can lower the death benefit at a later date but remember that it cannot be less than the total premium you’ve paid into your policy.
Although it will be your financial advisor’s responsibility to monitor your IUL to make certain your goals will be met, as the policyholder, you should take on the responsibility of reviewing the annual policy reports and speaking with your financial professional if you have concerns about the report or are confused about its content.
Because of the tax savings and the structure on the IUL, the IRA to IUL conversions have become extremely popular with the baby boomer generation across the U.S. This investment strategy provides a dynamic method to accumulate retirement funds and offers tax-free income during retirement.