Overview

Have you ever heard the term “Super Roth” [1] and wondered what is it? Perhaps you have not heard the term and you are curious about a Super Roth.

Truth be told, there is no such thing as a Super Roth (or Super Roth IRA), at least as far as the government is concerned. A Super Roth is a strategy, not a plan, that allows people to supplement their maxed-out Roth IRA with a life insurance retirement vehicle.

This article is written to explain for people from all socio-economic classes the concept of life retirement and the benefits afforded by life retirement vehicles. By the end of this article, you will understand;

• The value and benefits of life insurance retirement vehicles
• How to maximize cash accumulation in a life retirement plan
• How to identify and find a policy with low costs of insurance

A Super Roth allows people to make after-tax contributions into the plan irrespective of gross income with no limitation to the contribution amount. Super Roth’s are not bound to the same rules as IRA’s with respect to distributions and withdrawals.

Traditional IRA and Qualified Plan Basics

In 2019 and beyond, you are and will be lucky to work for a company that sponsors a retirement plan. The days of company-paid retirement plans are long gone unless you work for the federal, state or municipal government. You are lucky if your company even matches the employee’s contribution to a 401(k) plan.

The 401(k) allows a participant to defer up to $19,000 of earnings on a pre-tax basis in 2019. A participant that is older than age 50 may contribute an additional $6,000 per year

IRA contributions are the same for traditional and Roth IRAs. The amount of IRA contribution is reduced by the amount of contribution made to a Roth IRA. The IRA allows a taxpayer to contribute $6,000 in 2018 ($7,000 if the taxpayer is age 50 or older) if the taxpayer is a participant in a company-sponsored pension plan.

IF YOU ARE COVERED BY A PENSION PLAN AT WORK

(SEE LINK ABOVE) – If the taxpayer is a participant in a retirement plan, the taxpayer receives a full deduction on the contribution if adjusted gross income (AGI) on a joint basis is less than $64,000. If you are between $64,000 and $74,000 then you are entitled to a partial deduction. If you are above $74,000, you are NOT eligible for a deduction.

IF YOU ARE NOT COVERED BY A PENSION PLAN AT WORK

(SEE LINK ABOVE) – If the participant does not participate in a pension plan at work, the taxpayer is able to take a full deduction on the contribution without consideration on the level of adjusted gross income.

The tax rules for traditional IRAs or qualified retirement plan benefits require a taxpayer to begin required minimum distributions by April 1 in the year following the year in which the taxpayer reaches 70 ½. The IRS imposes a 50 percent excise tax on the difference between the required minimum distribution amount and the amount actually withdrawn.

The distributions are taxed as ordinary income rates. Distributions before age 59 ½ are subject to a 10 percent early withdrawal penalty. The account balance is included in the taxpayer’s taxable estate.

Roth IRA Basics

A taxpayer that files jointly is able to contribute to a Roth IRA if the taxpayer’s modified adjusted gross income (AGI) does not exceed $203,000. The contribution phases out between $193,000-203,000.

For a single taxpayer in 2019 contributions phase out between $122,000-$137,000. A taxpayer that is married and files separately is unable to make a contribution if modified AGI exceeds $10,000.

The calculation of modified AGI excludes the proceeds from an IRA rollover or a qualified plan. This important distinction generally speaking makes it easier for a taxpayer to position himself to do a conversion from a traditional IRA to a Roth IRA.

The primary difference between the Roth IRA and IRA or qualified plan is that the Roth IRA does not have required minimum distributions. Distributions from the Roth IRA are not subject to income taxation. However, the distribution must be a “qualified” distribution. Qualified distributions require five years of “seasoning” within the plan unless the taxpayer is at least age 59 ½.

Distributions before age 59 ½ are subject to the 10 percent early withdrawal penalty as well as normal tax treatment on the distribution (as if it were a traditional IRA). Like the IRA, exceptions to these rules exist for distribution for a first-time homebuyer; distribution to a disabled taxpayer, or a distribution to a beneficiary on account of the taxpayer’s death.

The account balance is included in the taxpayer’s taxable estate. At death, the remaining distribution of the account is subject to the same rules as the traditional IRA. A surviving spouse as the beneficiary of the Roth IRA can treat the Roth IRA as her own. Other beneficiaries must distribute the balance over their life expectancies.

The investment guidelines for a Roth IRA are similar to the restrictions for a traditional IRA. The policyholder can expand the investment guidelines through the use of a self-directed arrangement. The prohibited transaction guidelines applicable to the traditional IRA apply to the Roth IRA as well as the tax rules on unrelated business taxable income (UBTI)

Super Roth Basics

1. Overview

The Super Roth IRA uses after-tax contributions as premiums into a permanent life insurance policy – whole life, indexed universal life or variable universal life insurance.

These policies must be maintained in the corridor as prescribed by IRS Section Code 7702, simply meaning that a permanent life insurance plan must maintain a minimum amount of life insurance to qualify for tax-deferred growth and tax-free distributions.

The nature of these permanent life insurance vehicles is that they typically require a 7-10 year window for the cash accumulation to overcome the cost of insurance and the costs associated with managing the plan (i.e. commissions, premium loading, etc.) Once beyond the 7-10 year window, there are substantial benefits for permanent life insurance plans, as long as you stay within the 7702 corridor.

1. Tax Treatment

Permanent life insurance comes with substantial tax benefits. The cash value within the policy accumulates tax-deferred within the policy – AND – if you structure your plan to take LOANS and NOT WITHDRAWALS, the loans are TAX-FREE – NOT tax-deferred. Assuming a marginal tax rate of 22+%, consider life insurance to be 22+% of your plan as TAX FREE MONEY!

The plan participants may access the policy gains within the policy on a tax-free basis. Usually, the policyholder accomplishes the tax-free withdrawal by taking a partial surrender of the cash value up to the tax basis in the policy (cumulative premiums). Once the basis has been fully recovered, the policyholder is able to switch to tax-free policy loans.

If structured properly, loans are low cost and non-recourse to the policyholder. Once there is enough cash accumulation in the policy, policyholders can take advantage of the spread between the loan interest rate and crediting rate to ensure the principal may grow in perpetuity.

It is critical that the policyholder retains sufficient assets within the policy to cover policy costs. A policy lapse would be catastrophic for the taxpayer’s tax planning. In the event of a lapse, the loans would be treated as amounts received under the policy and subject to taxation at ordinary rates.

Unlike a traditional IRA or Roth IRA, the Super Roth is not subject to contribution limits, earnings caps, or restrictions or conditions on distributions during lifetime or at death as long as the policy is maintained within the corridor.

Depending upon the type of policy, or policies, chosen as well the insurance carrier, the policyholder has greater investment flexibility than within an IRA or Roth IRA.

1. Policy Design Considerations

In order to optimize a Super Roth for cash accumulation as an investment vehicle, the policyholder requires a sound design for maximizing growth and minimizing costs. There are many factors included in the cost, the largest cost factor is the premium loads associated with the required life insurance. The first year’s premium load will be substantially higher due to the sales commissions and other associated year one cost.

A permanent life insurance policy typically has a first-year commission of 110-120 percent of the policy’s target premium or commissionable premium.

NOTE: If considering a whole life, variable life or indexed life policy – BE AWARE OF HOW THE COST OF INSURANCE AND TARGET PREMIUM WILL IMPACT YOUR COST AND CASH ACCUMULATION.

The policy should be funded so that the policy is a non-Modified Endowment Contract (MEC). Non-MEC status is important. It preserves the tax-free treatment for policy withdrawals and loans from the policy. The policy design should use the guideline premium test tax law definition of life insurance.

Most Super Roth IRA’s are designed are “reversed engineered”, meaning that a client agrees upon a premium payment and the life insurance component is calculated from that premium applying “the guideline premium test” to determine death benefit and cash value components.

For a life insurance vehicle to be optimized for cash accumulation, the policy should have the minimum allowable death benefit based on the 7702 tax code so that the policy is ensured to be non-MEC over the life of the policy. Essentially, the policyholder is attempting to force as much premium into a policy with the least amount of death benefit so that the policy is a life insurance policy for tax purposes and a non-MEC.

NOTE: Once a policy fails to meet the guideline premium test and is categorized as a MEC (modified endowment contract), it is permanently not eligible for favorable tax treatment.

Virtually every universal life (indexed, traditional or variable) has a policy rider known as a term rider. This rider is non-commissionable within the policy. The policy should be designed to that the policy death benefit is largely covered by this term rider. Generally, a carrier will allow a mix of base coverage and this term rider in a ratio of 10-20 percent base coverage and 80-90 percent non-commissionable term rider. The term rider “dials down” the commission level within the policy.

As a result, the premium can be invested within the policy with a much smaller “haircut” providing a larger cash value on Day 1 for investment. The result is more money accumulating from Day 1 on a tax-advantaged basis. The net result is greater accumulation for retirement planning purposes.

Hear my word – your life insurance agent will not make this option available to you! You need to request this.

• Types of Policies

1. Whole Life

From an investment perspective, the policyholder should look at whole life insurance as a long term investment-grade bond. The crediting rate or dividend of whole life is tied to the investment performance of the life insurance company’s general account assets.

The investment of the general account assets is regulated by state insurance regulators. Generally, 85-90 percent of the general account assets are invested in long-term investment-grade bonds, mortgages and real estate. The general account has minimal exposure to the stock market but is interest-rate sensitive.

Participating whole life policies, or policies that pay dividends, have inherent advantages over non-participating whole life policies.

1. Variable Universal Life

Variable universal life insurance provides investor access to mutual fund-like sub-accounts managed by the best known mutual fund families (Fidelity, Oppenheimer et al). These assets are separate from the insurer’s general account assets, the policyholder bears the risk of the investment.

The policyholder receives a direct pass-through of the fund’s investment performance. Most products offer a very large assortment of fund choices (50-60) across a wide segment of investment strategies. If you can’t find a fund that you like, you aren’t looking hard enough!

1. Indexed Universal Life

Indexed universal life insurance, or IUL’s, is a direct descendent of indexed annuities. Once indexed annuities became popular and prevalent, the concept quickly spread to universal life.

Indexed universal life insurance policies are renewable term policies with a side cash account. The lower cost of insurance for term insurance provides more “bang for your buck” (more money allocated to cash accumulation) in a life insurance investment.

IUL’s provide flexibility and some level of guarantee on the crediting rate. The funds are credited by gains achieved in an equity-based index. The advantage to an indexed policy is downside protection (most policies have a floor of 0%) in exchange for a cap on the upside.

A Real-Life Case Study – 45 Year Old Real Estate Agent

The Facts

Jane Doe, a super healthy non-smoking female age 45, is an independent real estate agent. As an independent agent, Jane is responsible for her own retirement planning and funding. Jane has diligently maxed out her Roth IRA contributions over the past 10 years and is looking for a vehicle to continue investing for retirement. At Jane’s age, she would like a relatively safe financial instrument with a moderate upside for cash accumulation and growth.

Jane is willing to commit an additional $5,500 per year for retirement planning purposes and is planning on funding the plan for 22 more years, until age 67.

The Strategy

Jane applies for an indexed universal life policy. Jane is the applicant, the owner and the insured while her son John Doe Jr. is the policy beneficiary. The policy issued by one of the leading carriers. The carrier has the highest ratings from the independent rating agencies, A+ ratings for AM Best, Moody’s and S&P 500 with a best in industry Comdex (compilation) rating of 95.

Using the “reverse engineering” model described earlier, our case design is entered with $5,500 annual premium using a conservative illustration rate (the forecasted rate of return on cash value) of 6.38%.

NOTE: Long term performance for this carrier and policy is historically between 6.9% – 8.0% depending on allocation, hence 6.38% is very conservative.

In the Super Roth, the policy provides for an increasing death benefit of $159,047 of term insurance coverage on day 1. The cost for the death benefit coverage annually is about $1,500 for the first year. The projected cash value (premium cash value minus the cost of insurance) at the end of Year 1 based on the company’s dividend scale is $4,420 The projected cash value based on this policy design will exceed cumulative premiums between the 6th and 7th years.

In Year 23, Jane Doe age 68, the policy has a projected cash value of $258,295 (from a total of $126,500 in premiums over the previous 23 years) and a death benefit of $396,397. Jane is now able to take tax-free loans from the policy without penalty. In the event of death, John Doe Jr. receives the death benefit tax-free.

Policy distributions (loans) are tax-free and hence will not impact negatively impact the taxation of social security benefits. Additionally, in Jane’s state of residence, the policy is not subject to the claims of his personal creditors.

SUPER ROTH VS. ROTH IRA

Per the image below, a Roth IRA with the same annual contribution that earned a comparable 6.38% annual return would be worth $288,642 at retirement, after age 67, in the case study above vs. the $258,295 in a TAX FREE PERMANENT INSURANCE ACCOUNT (the Super Roth) – AND – with the Super Roth, there was an increasing death benefit coverage over the 22 years of the policy that was not included in the Roth. Also, all additional future gains in the Super Roth are TAX FREE vs. the taxable gains in the Roth.

Summary

The Super Roth is a more flexible alternative than a traditional IRA or the Roth IRA. One key factor in maximizing the benefit of the Super Roth IRA is to minimize the impact of sales load within the policy. Below is a list of key benefits and features for an Indexed Universal Life Policy.

The combination of tax advantages and institutional pricing allows the Super Roth to provide excellent retirement income and estate planning benefits, legacy building and generational wealth-building strategies.

[1] Super Roth IRA is a trademark of Reg Wilson of Epic Financial.