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This week I want to discuss a Sales Pitch that high earning professionals are likely to hear - if not, it is only a matter of time.
The sales pitch goes something like this: "How would you like to pay a 2% tax rate in retirement?" The salesperson will likely use terminology such as:
1.) Tax Free Withdrawals in Retirement
2.) The Bucket Strategy
3.) Cash Value Life Insurance
4.) Bank on Yourself
5.) COIL
The product being pitched is a form of Universal Life Insurance policy. I am not qualifying these products as good or bad. But if you are earning taxable income at the level of a Sr. Director or Officer at Walmart, the Walmart DCMP will likely save you more in taxes despite the "tax savings" sales pitch.
Opting for a Universal Life Insurance policy over contributing to the Walmart DCMP could be a six-figure mistake!
As a high earner in a 32 - 37% tax bracket, the best strategy is to minimize taxable income during your high earning years - also your highest tax years. The proposed "Bucket Strategy" using a Universal Life Insurance policy results in you realizing taxable income today to pay for the premiums - while you are likely in the highest tax bracket of your life. Furthermore, the sales pitch is that you will have access to tax free withdrawals while you are likely in the lowest tax bracket of your life during retirement. The logic is backwards...
Yes, tax efficiency is a great goal, but this is NOT a tax efficient strategy for high earning professionals including Sr. Directors and Officers at Walmart. It is the opposite.
The point of the article is to illustrate that a Universal Life Insurance policy may cost you significantly more in taxes and leave you much less wealthy than simply contributing to the Walmart Deferred Compensation Matching Plan.*
*There is a lot of "fine print" to Universal Life Insurance policies such as surrender charges, fees, sales commissions, participation rates, but the goal of this article is to simply challenge the claim that the Universal Life Insurance product is a tax efficient solution for high earning corporate professionals.
What is a Universal Life Insurance Policy?
These products are complicated and nuanced, but at a high level here is how they work:
1.) You pay a premium to the insurance carrier with your after-tax income.
2.) Your premium dollars are allocated between the cost of life insurance, fees and the cash value account.
3.) The goal is to grow your Cash Value account over several years which can be invested in a fixed rate account or sub-accounts that track the stock market.
4.) You are permitted to take loans against your Cash Value which (like all loans) is not taxable income. These are the tax-free withdrawals.
5.) At your passing, any outstanding loan proceeds are deducted from the death benefit your beneficiaries receive to pay back the loan. The insurance company typically absorbs the cash value account.
The advantage is that the Cash Value account grows tax deferred, and you likely will not pay taxes on the withdrawals in retirement. From a tax perspective, the problem is that the high earning executive must use taxable income to pay these premiums today while in the highest tax bracket of their life!
Yes, there are no taxes on the loan proceeds in retirement (i.e. tax-free withdrawals), but you already paid a huge tax bill when you initially generated taxable income to pay the premiums.
Wouldn't it be better to defer taxes on income today and pay a lower tax rate in retirement? As a Walmart Sr. Director or Officer, you have that option!
Universal Life Cash Value vs. Walmart DCMP
As a Walmart Sr. Director or Officer, you have access to several tax advantaged accounts including 401(k), Health Savings Account, Backdoor Roth IRA and, most importantly, the Walmart Deferred Compensation Matching Plan (DCMP).
For simplicity, I want to compare the tax efficiency of the Walmart DCMP and a Universal Life Insurance policy.
The Walmart DCMP allows Walmart Sr. Directors and Officers to contribute pre-tax income to the Plan, the contributions grow tax deferred, and the taxable distributions are disbursed over a set number of years after you leave the Company. For more details on the Walmart DCMP, see the below posts:
Now, let's Look at Two Scenarios: Lump Sum and Ten Year.
Scenario #1: Lump Sum
The Lump Sum scenario considers a single $100,000 contribution in Year 1 and the value of that contribution 10 years later. For simplicity, let's assume the entire premium is allocated to the Cash Value account AND the cost of insurance is equal.*
*A portion of the Universal Life premium pays for the cost of insurance - essentially a 1-year term policy that is renewed each year. For simplicity, in the Walmart DCMP case let's assume you purchase a term policy of equal cost. So, those costs would cancel each other out. We will not factor in fees/commissions on the life insurance option.
Assumptions: 6% Annual Growth Rate, 35% Marginal Tax Rate in Year 1, Tax Rates Based on 2023 Tax Table (MFJ), No Additional Taxable Income in Year 10 and Standard Deduction is $27,700.
At the end of 10 years, you pay $11,000 less taxes with the Walmart DCMP option. More importantly your wealth is $38,000 more because - in addition to paying less taxes - you earned a return on the deferred taxes for 10 years!
Scenario #2: 10 Years of Contributions
Now, let's extend the above scenario for 10 years of contributions. Instead of a single contribution in Year 1, you contribute $100,000 to the Universal Life Insurance policy or Walmart DCMP for 10 years.
Assumptions: 6% Annual Growth Rate, 35% Marginal Tax Rate in Contribution Years, Tax Rates Based on 2023 tax table (MFJ), $27,700 Standard Deduction, No Investment Growth during distribution period, and No Additional Taxable Income during distribution period
In this scenario, your wealth is $336,000 higher with the Walmart DCMP option! At the end of 10 years the Universal Life Cash Value is $908,000 and the Walmart DCMP is $1,400,000.
Of course, you still must pay taxes on the Walmart DCMP at distribution. If you elected to receive the entire amount in a single year, you would pay a lot of taxes. But, you could elect to receive 10 annual installments of ~140,000 which is taxed at an effective rate of ~11% each year (2023 MFJ Tax Table.)
In sum, the Walmart DCMP allows for more dollars to be invested for longer AND allows you to access your money at a significantly lower tax rate.
Wrap-Up
Again, the point is NOT to qualify the Universal Life Insurance policy as a Good or Bad product. The product could be a solution for some people especially those needing estate tax solutions. Or, it may have made sense for someone earlier in their career.
The point of the article is to show that it is NOT a tax efficient solution for high earners in high tax brackets who will transition to a much lower tax bracket in retirement.
If you want to learn more about Cash Value Life Insurance policies, see the below articles:
As always, I appreciate you taking the time to read these letters. I know they are long, but I hope they are helpful.
Thanks for reading,
Mark Chisenhall, CFA, MBA
Taurus Financial Planning is a Fee-Only Wealth Management firm based in Bentonville, AR. The firm offers tax-efficient financial planning and investment management to corporate professionals.
Taurus Financial Planning is a Registered Investment Advisor with the State of Arkansas. This information is provided as a guide to assist you in your financial planning. The specific examples are provided for illustration purposes only and are not representative of specific investments or guarantees of future returns. Please consult with a professional for specific questions regarding your particular situation. If there is any error or inconsistency between this document and the official company plan documents, your company plan documents will govern.
This publication is for informational purposes only and is not intended as tax, accounting or legal advice or as an offer or solicitation of an offer to buy or sell or as an endorsement of any company security fund or other securities or non securities offering. This publication should not be relied upon as the sole factor in an investment making decision. Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any recommendations made by the Author, in the future, will be profitable or equal the performance noted in this publication.
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