How to Pull Some New Life Out Of Old Life Insurance Policies

Do you own any life insurance policies that have outlived their usefulness? It could be a universal life policy that has very little cash value. Or you might have a term policy that is about to renew, but the new premiums are out of reach. And of course, there’s always the possibility you no longer need the insurance. Rather than letting those policies just lapse, there could be some tax benefits that could possibly translate into more income for you or your beneficiaries. One idea worth considering is a 1035 Exchange on the life insurance policy to a tax-deferred annuity. 1035 refers to a provision in the tax code that allows for the direct transfer of accumulated funds in a life insurance policy or annuity to another life insurance policy or annuity without creating a taxable event. For example, let’s say you own a life insurance policy you no longer need. Over the years you had paid in $100,000 worth of premiums, and now it has a $20,000 cash value. Meanwhile, you’ve been looking for a way to get some income sometime in the future. You may think that there couldn’t be much of a benefit if there’s very little cash value in the policy. But for tax purposes, the amount transferred is actually the cost basis. In the above example, since you had put $100,000 into the life insurance and it’s only worth $20,000, you have an $80,000 loss. By using the 1035 Exchange, you’ll increase the annuity’s cost basis from $20,000 to $100,000. This means when you or your beneficiaries make withdrawals, an additional $80,000 of growth will come out income-tax free. The IRS has more info on its Web site. Just click here and insert 1035 Exchange in the search box. Nevertheless, before you take this route, go over the strategy with your advisors. Good luck! George

As Goes California, So Goes the Nation?

For better or worse, California is known as a trendsetter. From cool cars to the Beach Boys to legalized pot growing in Mendocino County, California often leads the rest of the country in new directions. But the other day, I came across a poll of California voters age 40 and older on long-term care published by UCLA that got me thinking: Were Californians exposing a problem that other Americans ignore? Let me give you some highlights:

• Fifty-seven percent say they could not afford more than three months of in-home care. One in three say they could not afford even one month of in-home care.
• Sixty-six percent say they could not afford more than three months of nursing home care, while 42 percent say they could not afford even one month of care.
• Thirty-five percent of Republicans, 38 percent of Democrats and 26 percent of independents say they would not be able to pay for even one month of in-home personal care; 43 percent of Republicans, 48 percent of Democrats and 33 percent of independents say they could not afford even one month of nursing home care.
• Only 15 percent report having long-term care insurance.
• Just 20 percent were aware that Medicare does not cover ongoing in-home personal care; similarly, only 30 percent knew that Medicare does not cover prolonged nursing home care.
• Ninety-five percent say they prefer having affordable care options in the community in order to avoid going to a nursing home.

You can click here to read the complete findings. So what should all this mean to other Boomers? You need to ask yourself: Are you as ill-prepared as these Californians, but you stick your head in the sand? You better have a plan of action in case your health changes during retirement, which it almost certainly will. Otherwise you could end up somewhere you don’t like and be flat broke, too. Best wishes, George P.S. To understand your options, check out my book A Boomer’s Guide to Long-Term Care.

How to Avoid the 10% Penalty on IRA Withdrawals

Are you under 59½ and considering an early retirement? So what’s holding you back? Is it because the majority of your money is tided up in your IRA, and you don’t like the idea of paying the 10% penalty for early distributions? There might be a way around that … IRS Rule 72(t). Section 72(t) of the Internal Revenue Code allows taxpayers of any age to take a series of substantially equal periodic payments without a 10% penalty. The payments must continue for five years or until you reach 59½, whichever period is longer. While you’re receiving the money, you cannot make any changes to the payments. Each IRA stands on it own, meaning that taking 72(t) distributions from one account has no effect on the others. Therefore, if one IRA will produce more income than is needed, you could set up a smaller, segregated account to withdraw from. And in the future, if you need more income, you could begin equal distributions from another account as well. This could provide greater flexibility in meeting your immediate and future income needs. There are three ways to calculate 72(t) distributions:

• The Minimum Distribution Method is calculated the same way as required minimum distributions when account owners reach their required beginning distribution date. This method will generally produce the lowest annual 72(t) payments since it is based on the longest life expectancy.
• The Fixed Amortization Method consists of an account balance amortized over your life expectancy. Once an annual distribution amount is calculated under this fixed method, the same dollar amount must be distributed in subsequent years. This produces higher payments than the Minimum Distribution Method and gives some security in that the payments are fixed. But the calculation is complicated and there is the risk that the payments will not keep pace with inflation.
• The Fixed Annuitization Method consists of an account balance, an annuity factor, and an annual payment. Once an annual distribution amount is calculated under this fixed method, the same dollar amount must be distributed under this method in subsequent years. This method may at times provide the largest payments, depending on the size of the account and interest rates used. And like amortization method, the payments are fixed.

Is taking advantage of Rule 72(t) a good idea? It could be. After all, it gets you out of paying the 10% penalty. But remember: You’ll still have to pay ordinary income taxes on the distributions, and money you withdrawal from your IRA means that much less for your future needs. And in case you don’t stay with the plan, or modify the payments in any way, you will no longer qualify for the exemption from the 10% penalty. Furthermore, the 10% penalty will be reinstated retroactively, to all prior years.

So before you take advantage of Rule 72(t), I suggest you get a second or even third opinion before signing on the dotted line. Best wishes, George