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Updated: May 4, 2021

Is an IRA-to-IUL Conversion Strategy Right for You?

Converting retirement funds from a tax-deferred status to a tax-free status is nothing new. Over the past decade, more and more Americans – helped by financial professionals – are realizing deferring taxes may not be in their best financial interest. In the past, most Traditional IRAs were converted into tax-free Roth IRAs. Today, funds from a growing number of IRAs are being placed in Indexed Universal Life (IUL) insurance policies. One potential reason: IUL can provide four powerful benefits to today’s savers:

• The power of indexing to deliver growth potential with protection from market losses

• Tax-free supplemental income through policy loan2

• Access to funds with no market-value adjustment

• A legacy for beneficiaries above the account value

Thanks to these benefits, IUL has become a key component of holistic planning for a growing number of Americans. Many financial professionals understand that IUL can deliver a package of features not found in other savings vehicles.

The primary purpose of life insurance is death benefit protection. Some policies, like indexed universal life insurance, can also accumulate cash values that can be used to supplement income needs in retirement. Life insurance policies are contracts between the client and the issuing insurance carrier. Like insurance guarantees rely on the fiscal strength and claims paying ability of the issuing insurer. Life insurance products are not

FDIC insured. Permanent life insurance policies require monthly deductions, which include cost of insurance, expense charges and potentially other charges. These deductions may reduce the cash value of the policy.

Indexed universal life insurance is not a registered security or stock market investment and does not directly participate in any stock or equity investments or index. The index used is a price index and does not reflect dividends paid on the underlying stocks.

Policy loans are not generally subject to income tax unless the policy is classified as a modified endowment contract (MEC) under IRC Section 7702A. Policy loans reduce available cash values and death benefits. Tax laws are subject to change. Please consult a qualified tax professional about your individual situation.

What is an IRA-to-IUL Conversion?

An IRA-to-IUL conversion is a process by which you withdraw a portion of your IRA funds, pay taxes on the proceeds, and use the net amount to purchase a permanent life insurance policy that builds cash value.

You may be familiar with the term “IRA Rollover,” which describes transferring funds from one IRA account to another. You may also be familiar with the term “Roth Conversion,” which describes moving funds from a qualified account to a post-tax Roth account.

An IRA-to-IUL conversion is neither of these approaches, but shares some commonalities with each. Like an IRA rollover, an IRA-to-IUL conversion moves funds from one vehicle to another. Like a Roth conversion, an IRA-to-IUL conversion involves paying taxes now on assets moved from a tax-deferred account to a tax-free vehicle.

An IRA-to-IUL conversion can be part of a holistic planning approach to help maximize and balance the financial growth, stability and tax benefits of your overall retirement strategy.

Is an IRA-to-IUL Conversion Strategy Sound?

Like many financial strategies, IRA-to-IUL conversions can be beneficial for some, while not appropriate for others. Additionally, as with any insurance strategy, proper structuring of the policy is critical to help ensure your goals and objectives for purchasing the policy are met.

At its core, an IRA-to-IUL conversion strategy is a two-step decision-making process:

1. Does it make sense for you to save in a tax-deferred vehicle or a post-tax vehicle?

2. If the answer is a post-tax vehicle, is IUL the right vehicle?

There are six key areas to consider before moving forward with this approach. Reviewing each of these areas can help you determine if this approach is right for you, and how to best execute the strategy.

1.) Are you a good fit for this strategy?

The answer is yes, with important qualifications.

Most of the time, an IRA-to-IUL conversion strategy is not appropriate for your entire IRA account balance. So make sure this strategy is a good fit for you before allocating any portion of your IRA to an IUL policy.

2.) Analyze your IRA to make an informed decision

How do you know if an IRA-to-IUL conversion will improve your retirement income strategy? Start by analyzing your current IRA.

Important considerations include:

• Total tax liability: How much in taxes will the IRA generate over your lifetime? Based on this analysis, your financial professional can help you decide if moving IRA funds from a tax deferred status to a post-tax status makes sense.

• If the answer is yes, you can analyze:

° After-tax growth potential: Using reasonable assumptions for growth and taxation, what would the post-tax IRA value be in 10, 20 and 30 years?

° Less favorable market growth: What would happen to the IRA value if market performance is less favorable than assumed?

3.) Compare the IRA analysis to an IUL illustration

Working with your financial professional, compare after-tax growth in your IRA to after-tax growth in an IUL policy. Together, you can evaluate the results.

4.) Handle taxes responsibly

You will owe taxes on the funds coming out of your IRA. In order to determine the best approach for paying those taxes, you should consult with a qualified tax advisor.

• IUL premiums should be set using post-tax amounts from an IRA.

° For example, Bob withdraws $50,000 from his IRA this year and has a 25% tax liability. His IUL premium for this year should be $37,500 ($50,000 x .75).

• You should not use IUL policy loans to pay taxes.

° For example, Bob should not pay an IUL premium of $50,000 this year, and then take a policy loan for $12,500 to pay the taxes owed.

° Using policy loans to pay taxes puts your IUL policy at risk. Early-year loans can stress an IUL policy, particularly if indexing credits are lower than expected.

A sound IRA-to-IUL conversion strategy will handle taxes outside the IUL policy, and then compare growth in the IRA and IUL using the net-of-tax premiums and values.

5.) Funding the IUL Policy

It’s important to fund your IUL policy in an efficient way. This means balancing two interests:

• Getting funds into the IUL policy quickly, to maximize accumulation.

• Ensuring the premium pattern does not cause the IUL policy to become a MEC1 as loans from a MEC are not tax free.

A 5-pay premium2 is generally the ideal premium payment structure for an IRA-to-IUL conversion strategy.

• A 5-pay moves premiums into the policy quickly while ensuring the policy does not become a MEC.

• It also distributes the impact of paying taxes on withdrawn IRA funds over more years, compared to a more rapid funding pattern.

° In some cases, a 7-pay or even 10-pay2 may be appropriate to avoid moving into a higher tax bracket in any given year.

6.) Death Benefit

The death benefit is an important consideration. After all, IUL can deliver something an IRA does not: A legacy above and beyond the account value. In fact, death benefit protection is the primary purpose of life insurance.

• Depending on your situation and needs, it may make sense to set the death benefit at the minimum allowed by IRS guidelines.

° This minimum death benefit will ensure the policy does not become a MEC, and the tax status of your funds will not be at risk.

• You should not dramatically lower the death benefit during the early policy years. Doing so risks making the policy a MEC.

° If you choose to lower the death benefit in future policy years, be sure the

reduction does not result in a death benefit less than the total amount of premium paid.



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