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Comparing leaving money in a 401K/IRA or paying penalty and putting it into a EIUL February 25, 2014

Posted by shaferfinancial in Finance, Uncategorized.
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This subject is somewhat controversial because of the penalties involved in taking money out of a 401K/IRA before age 59 1/2. But I thought the readers would like to see the math behind this suggestion. I will do it for both age 45 male and age 60 male which wouldn’t have to pay the 10% penalty, just taxes.

I assume the same 45 year old man as in the last post. He takes out $135,000 which ends up being $100,000 after taxes and penalty. The comparison is leaving the $135,000 in his 401K compared to putting in $100,000 over the minimum time [4 years + 1 day] into an EIUL. I use actual index returns from the last 22 years on both sides of the equation. Again, I take out no expenses from the index mutual fund and take out actual expenses from the insurance policy.

The $135,000 left in his 401K for the last 22 years would be $593,285. Using the same safe 4% withdrawal rate puts his pre-tax income at $23,731. But it is taxable, so assuming the same 25% income tax rate your have approximately $17,800 in post tax dollars to spend each year from the 401K/IRA.

If this man had put $20K for 5 annual payments into an EIUL what would he be able to take out? The tax free annual income would be around $43K per year from age 68 until age 90. At age 67 he would have $457,000 or slightly less than in his mutual fund. But remember the point here is what you have in your pocket each year. $43,000 or $17,800???? The math is the same. Pay taxes up front and not wait to pay taxes when the amount is several times larger. No sequence of return risk. And life insurance which will still pay to his heir more than he put in no matter when he dies.

Once again, using the assumption that the next 22 years will be similar to the last renders a large advantage for the EIUL. As well as a large reduction in risk both to your retirement income and your family.

Our second example, is really pushing it for the strategy. Generally I suggest leaving the total amount in the life insurance policy for a minimum of 15 years. That would take a 60 year old to 75 years of age. However, since the rules require distribution from the IRA at age 70 1/2 I decrease the length of time to 10 years.

I use a 60 year old man [women work just as well if not better], in generally good, but not perfect health.
He pulls $125,000 out of his IRA/401K and pays his 25% tax leaving $100,000 for the premium.

That $125,000, using actual returns for the last 10 years, renders $206,293. He can safely take out $8,251 in pre-tax dollars or using the same 25% tax rate $6,189 after the tax man is paid.

So how about the life insurance policy? We have now stressed the policy to its max with taking out income after only 10 years. You can take out around $14,000 per year from age 70 until age 90.

So even in the worst case situation, stressing the life insurance policy, it renders higher annual income.

One more comment. Recently, I have been working with a someone who wants to leave a non-profit an inheritance. He doesn’t want to take a risk and give the money now in case he would need the money later in life. So, we are structuring a life insurance policy that will keep him in control of his money. If he wants to he can take cash out and use it for himself or give it away. Or, he can just let the policy ride and the death benefit increase. Each year he can make this decision differently if he wants. Finally, he will start it with his wife as the beneficiary, but hopes to change that as he gets older and the risk of needing the money decreases to the non-profit. He can even split the beneficiary for his wife and the non-profit. All this can be changed as he wants to. This leaves him in control of his money.

Recently, I was advised that 401Ks can have life insurance policies in them. So if you own a business and have the ability to write the rules for your 401K, you can avoid paying the tax and hold the life insurance inside of your 401k. There are some benefits to doing this.

Just a thought!



1. Andy baker - February 1, 2015

I am intrigued, as I have been contemplating this for a while. Why is the w/d rate on the 401k 4% and on the eiul it is closer to 10%? Can you provide more detail on this via private email?

shaferfinancial - March 8, 2015

It is about those negative numbers. When the market goes down [sometimes as much as 40%] and you pull out money, it creates a situation where the time you need to recover is impossible in retirement. Since EIULs never go down, you don’t have to recover.

shaferfinancial - February 23, 2016

Its a function of not having a risk of negative years. The 4% rate is for a product that will have multiple negative years including most likely some in excess of 25% negative. The rate for EIULs has the capital increasing as it did during the whole policy. That is, each year between 0% and 17% plus the bonus [after year 10]. Such is the power of sequence of return risk or the power of not going negative.

2. Andy baker - February 1, 2015

I guess I would like to see the side-by-side / year-by-year comparison to see when the money runs on out on each. Thanks.

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