In last week’s edition of Retirement Watch Weekly, I introduced readers to the Family Bank Strategy. Today, we’ll answer some commonly asked questions about it, starting with…
Who should consider the Family Bank Strategy?
One good candidate is someone who is keeping money in conservative investments as a safety net or in case someone in the family has an unexpected need.
It’s not money that’s designated for regular living expenses.
He could transfer some of this money into permanent life insurance and establish a Family Bank.
Another good candidate is someone with a large IRA, either a traditional or a Roth IRA.
The traditional IRA eventually triggers income taxes. You’ll also be required to take minimum distributions after age 72 that are subject to income taxes.
Your beneficiaries who inherit what is left will be required to take minimum distributions and pay income taxes.
In this situation, everyone might be better off if money is taken out of the traditional IRA today, the taxes paid, and the after-tax amount put in permanent life insurance.
The future earnings on the cash value will accumulate tax-free, and will compound for the rest of your life if you want.
If money is needed, it can be taken tax free as loans.
Eventually, your beneficiaries inherit the life insurance benefit tax-free.
This strategy is especially good when you convert only enough of your IRA to bring your taxable income up to the maximum of your tax bracket.
For example, a couple earning $150,000 will be in the 28% federal income tax bracket until their income reaches $226,850.
They could transfer another $76,000 annually from the IRA into the Family Bank Strategy before jumping up to the 33% bracket.
The really big advantage is that the life insurance benefit is always going to be worth substantially more than the money you transferred into the policy.
And, unlike an IRA, market changes aren’t going to cause the insurance policy’s value to decline.
If your loved ones inherit a traditional IRA, they’ll really inherit only the after-tax balance.
Even a Roth IRA owner might be better off with the Family Bank Strategy.
If the Roth IRA exceeds your likely needs and primarily is for loved ones to inherit, consider turning it into a permanent life insurance policy.
That way, your beneficiaries will inherit the tax-free policy benefit, which is going to be higher than the Roth IRA balance.
There’s no investment risk with the insurance policy, and you still have tax-free access to the money through loans.
The Family Bank Strategy also should be considered by someone who still is working and has excess cash flow.
The savings need to be invested. The Family Bank Strategy might be the best long-term use for some of that money, especially when the contribution limits already are reached for 401(k)s and IRAs.
Consider this example. Max Profits, age 60, is in good health and he wants to transfer $200,000 into The Family Bank Strategy.
Instantly, he increases his estate to $795,890, four times the deposit, because of the life insurance benefit.
His cash account at the end of the first year will be $203,195 and will grow to $295,091 in 10 years and $516,768 in 20 years, assuming 7% interest.
The formula used in this example to credit the cash value account has an average annual 30- year return of 7.6%.
There are four general types of permanent life insurance, and many variations of each.
For the Family Bank Strategy, you only want to consider Participating Whole Life or Indexed Universal Life.
There’s a vigorous debate among insurance professionals who implement the strategy over which type of policy to use.
You need to know the arguments on each side and decide which is best for you.
For many of you, the Family Bank Strategy is a way to lock in the value of your estate for loved ones, earn a solid tax-free return on your cash value, and have tax- free access to the capital when you need it.
It can play an important role in increasing your family’s after-tax wealth.
Publisher’s Note: While the Family Bank Strategy is a great way to increase and maintain the value of your estate, there are many other ways to ensure your family is well taken care of for years to come. I’ve laid them out in my step-by-step workbook To My Heirs. Claim your copy here.