Tax Diversification – The Bucket List

Tax Diversification – The Bucket List

Asset diversification plays a pivotal role within one’s investment account, though you don’t hear much about an equally important form of diversification: tax diversification. There are three forms of tax “buckets” that are each taxed differently.

After-tax holdings

These are your basic savings and investment accounts. Gains within the account are taxed at a capital gains rate, typically lower than an ordinary income rate.

Tax-deferred holdings

These are your qualified retirement accounts, i.e. IRA and 401(k) dollars. Tax free dollars invested, grows tax free but upon distribution taxed at your future ordinary income tax rate.

Tax-free holdings

These are the investments that allow you to avoid future taxes on the investment. Assets held in Roth accounts and municipal bonds are the most common form. Cash value life insurance, structured appropriately can generate tax deferred growth and tax free distributions.

Most individuals have their retirement assets in tax deferred investment accounts. These serve a very important role in one’s overall financial plan – but the tax in these accounts will one day have to be paid, creating a growing debt on these retirement savings. Future tax will be paid at an unknown and likely at a higher rate.

It’s important to plan with tax diversification in mind. It will ultimately pay to make sure you have access to tax-free money, tax-deferred money and some taxable money, especially during the withdrawal phase of retirement.

Let’s explore an idea within the “Tax-Free Bucket”; cash value life insurance.

Below is a hypothetical healthy 30-year-old female funding $500 a month over a 20-year period into an Indexed Universal Life Policy*:

  • Age 70 – Cash Value $670,996 – Death Benefit $778,355
  • Age 80 – Cash Value $1,254,329 – Death Benefit $1,317,045
  • Age 90 – Cash Value $2,323,861 – Death Benefit $2,440,054

*Assumed interest rate of 6%

Keep in mind these policies can be structured many ways. The above has been structured to favor cash value accumulation. Contact your Life Insurance Specialist for detailed information about a plan that meets your client’s needs and budget.