"Private Pension" or Non-qualified*
When a person has contributed the maximum to their IRA, 401(k), or other employee retirement plan, yet still wishes to invest additional dollars and receive tax preferential treatment on those investment dollars, a non-qualified plan or "private pension plan" may make a lot of sense.
Among the most popular vehicles used today are variable annuities* and variable life* insurance, although traditional annuities and traditional cash value insurance are still used as well.
There is a distinction in the tax treatment of qualified plans such as 401(k), 403(b) and IRA's and that of non-qualified plans. For example, in a 401(k) plan, the investor receives an up front tax deduction, the money grows tax deferred, and upon withdrawing the money (no later than 70 ½) the investor will pay taxes at that point. In contrast, a variable life policy provides no up front tax deduction. However, it does provide similar tax-deferred growth. Most notably, if done correctly, the variable life policy is able to pay out benefits to the policy holder free of tax through the use of cost basis withdrawals and tax-free loans. Therefore, the 401(k) provides the tax benefit up front, whereas the variable life policy provides the tax benefit on the back end. Again, both enjoy the significant benefit of tax-deferred growth. It should be noted that variable life and variable annuities have expenses associated with these benefits that other investments typically do not have. As variable life is indeed life insurance, one should have a specific need for insurance in addition to a need to put away money on a tax preferred basis. Variable annuities have a mortality & expense fee which mutual funds typically do not have. Although there are additional expenses associated with these products, it should be noted that there are additional benefits delivered by these products that are not typically associated with other investments such as a death benefit.
It should be noted that a common misconception is that a person will be in a much lower tax bracket when they retire. This should be a mistake. This would mean that a person has much less income during their retirement years versus when they were working. What kind of retirement strategy places an individual in a lower standard of living at retirement? This is absurd. For many people, this strategy is not only inaccurate, but highly undesirable. The successful investor will have just as much if not more income during his/her retirement years. This being the case, it behooves investors to beware of having only one source of retirement capital, such as taxable 401(k) money. Tax rates today are historically low, even though the highest federal bracket is 38.6%. When a person has only one source of retirement capital and it is taxable, they run a depletion risk. In a 35% bracket, a person would have to take out $1.54 from their 401(k) plan for every $1.00 they wish to spend. For example, a person that wanted an after tax income of $100,000 per year would actually have to pull out $154,000 per year to meet this income need, provided they are in a 35% tax bracket. This negative dynamic is a serious problem.
What’s the solution?
The savvy investor will have accumulated multiple "buckets" of capital. One bucket such as the 401(k) plan will be taxable. Another bucket of tax-free capital can come from a variable life policy.* Strategically drawing from each of the buckets to make sure you are not thrown into a higher tax bracket unnecessarily is a fundamental and sound technique to minimize your tax exposure and maximize your retirement income.
Therefore, having non-qualified or "private pension plans" such as variable life insurance can make a lot of sense.
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