Written by
Martin H. Ruby, FSA
CONVERSION
STRATEGY:
WHAT TO CONSIDER
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, many 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. And it’s easy to see why: IUL can
provide four powerful benefits to today’s savers:
• The power of indexing – growth potential with
protection from market losses
1
Tax-free income through policy loans
2
Access to funds with no market-value adjustment
• A legacy for beneficiaries above the account value
1
Indexed universal life 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.
2
Policy loans and withdrawals are not usually subject to income tax unless
the policy is classified as a modified endowment contract (MEC) under
IRC Section 7702A. Policy loans and withdrawals will reduce available cash
values and death benefits and may cause the policy to lapse. Additional
premium payments may be required to keep the policy in force. In the event
of a lapse, outstanding policy loans in excess of unrecovered cost basis will
be subject to ordinary income tax. Tax laws are subject to change; consult a
tax professional about your personal situation.
Thanks to these benefits, IUL has become
a key component of holistic planning for
a growing number of Americans. Financial
professionals understand that IUL can
deliver a package of features not found in
other financial vehicles.
What is an IRA-to-IUL Conversion?
An IRA-to-lUL 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.
3
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 tax-free Roth account.
An IRA-to-lUL conversion is neither
of these approaches, but shares some
commonalities with each. Like an IRA
rollover, an IRA-to-lUL conversion moves
funds from one vehicle to another.
Like a Roth conversion, an IRA-to-lUL
conversion involves paying taxes now on
assets moved from a tax-deferred account
to a tax-free vehicle.
An IRA-to-lUL conversion can be part
of a holistic planning approach to help
maximize and balance the growth
potential, risk and tax eciency of your
overall retirement portfolio.
Is an IRA-to-IUL Conversion
Strategy Sound?
The answer is yes, with important
qualifications.
Like many financial strategies, IRA-to-
lUL 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.
3
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.
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 tax -free
vehicle?
2. If the answer is a tax-free vehicle, is IUL
the right tax-free vehicle?
There are six key areas to consider prior
to 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.
Are you a good fit?
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.
Funds in an IUL policy need time to
accumulate. Therefore, an IRA-to-
lUL conversion should only be used
for the portion of your IRA that
is not needed for income in the next
10 years.
Life insurance policies require
medical, and possibly financial,
underwriting to determine eligibility.
Remember: an IRA-to-lUL conversion
should be just one piece of your
retirement planning strategy.
Analyze your IRA to make an
informed decision
How do you know if an IRA-to-lUL
conversion will improve your retirement
approach? Start by analyzing your current
IRA. Important things to consider include:
Total tax liability: How much in taxes
will the IRA generate over your
lifetime? Based on this analysis,
you and your financial advisor can
decide if moving IRA funds from a tax-
deferred status to a tax-free status
makes sense.
If the answer is yes (it makes sense to
move funds to a tax-free status), 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?
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.
#1:
#2:
#3:
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, Davis Smith
withdraws $50,000 from his
IRA this year and has a 25% tax
liability. Thus, his IUL premium
for this year should be $37,500
($50,000 x .75).
#4:
You should not use IUL policy
loans to pay taxes.
For example, Davis Smith 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
interest credits are lower than
expected.
A sound IRA-to-lUL 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.
Funding
It’s important to fund your IUL policy
in the most ecient 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
modified endowment contract (MEC),
as loans from a MEC are not tax-free.
4
A 5-pay premium is generally the ideal
structure for an IRA-to-IUL conversion
strategy.
A 5-pay structure moves premiums
into the policy quickly while helping
ensure 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 a
10-pay premium structure may be
appropriate to avoid moving into a
higher tax bracket in any given year.
Death benefit
The death benefit is an important
consideration. After all, an IUL policy
delivers something an IRA cannot: A legacy
above and beyond the account value.
Key point:
Depending on your personal
circumstances, it may make
sense to set the death benefit
at the minimum allowed by IRS
guidelines. This minimum death
benefit will help 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 after the first few 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.
#5: #6:
4
A MEC policy is one in which the life insurance limits exceed certain high levels of premium, or the cumulative
premium payments exceed certain amounts specified under the Internal Revenue Code. For policies that are
MECs, distributions during the life of the insured, including loans, are first treated as taxable to the extent of
income in the contract, and an additional 10 percent federal income tax may apply for withdrawals made prior to
age 59 ½.
IRA-to-lUL conversions
are growing in popularity
for good reason. If you
are a pre-retiree or retiree
looking for death benefit
protection, growth potential
with protection from market
losses, the ability to diversify
retirement assets, and the
tax advantages of a properly
structured life insurance
policy, you may want to
consider an
IRA-to-IUL conversion.
Investment advisory services oered through Kingdom Financial Group,
LLC, an SEC Registered Investment Advisor. Fullerton Financial Planning and
Kingdom Financial Group are independent firms helping individuals make
retirement income planning more successful by using a variety of strategies to
custom suit their needs and objectives. By contacting us you may be provided
information about insurance products and investment opportunities. Investing
involves risk, including the potential loss of principal. None of the information
contained herein shall constitute an oer to sell or solicit any oer to buy
a security or insurance product product. Annuity product guarantees are
subject to the claims-paying ability of the issuing company, and are not
oered by Kingdom Financial Group, LLC.
This document is designed to provide general information on the subjects
covered. It is not, however, intended to provide specific legal or tax
advice and cannot be used to avoid tax penalties or to promote, market or
recommend any tax plan or arrangement. Individuals are encouraged to
consult with a qualified professional before making any decisions about their
personal situation. Life insurance agents do not give legal or tax advice.
Guarantees and protections provided by insurance products are backed by
the financial strength and claims-paying ability of the issuing insurer.
926638
Corporate Oce:
14155 N. 83rd Ave., Suite 144
Peoria, AZ 85381
Tempe Oce:
600 E. Rio Salado Pkwy., Suite 102
Tempe, AZ 85281
Phone: (623) 974-0300
Fax: (623) 974-0330
info@fullertonfp.com
www.FullertonFP.com
Prepared on behalf of: