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Strategically Allocate Assets Today to Manage Future Taxes

Strategically Allocate Assets Today to Manage Future Taxes

December 16, 2022

The majority of savings tools Americans rely upon to accumulate funds for future income are tax-inefficient – either during establishment, during the accumulation phase, or at distribution.  Figuring out where and how to invest to minimize taxes, while adhering to a suitable risk management profile, is confusing and challenging for even the most sophisticated investors.  A growing strategy to safeguard invested funds and income from taxation is the use of institutionally structured and priced cash value life insurance policies.  Previously available only to public and large private companies as corporate owned life insurance (COLI), these “corporate-lite” life insurance policies are designed with lower costs and are now available to be purchased by individuals. 

The planning team at Cedar Point Financial Services LLC works with clients in designing and implementing asset allocation strategies to minimize taxation and maximize future income.  

Decide When to Pay Taxes 

Tax diversification comes from allocating assets across various tax treatments.  As a variety of assets are accumulated, it is important to understand how each asset will be treated now and in the future.  Since tax rates for all assets are not the same and do not rise and fall together, the tax treatment of assets should be planned with diversification in mind to minimize tax leakage.  This provides the ability to hedge against future tax rate volatility and to take advantage of future tax rate decreases should they occur. 

In his book, “Wealth: Grow It, Protect It, Spend it, and Share It”, wealth manager and heir to the Carnation Company fortune, Stuart E. Lucas, describes the three zones of tax diversification as Tax Now, Tax Later and Tax Never and he assigns classes of assets to each. 

Tax Now – taxes are due upon the gain of these assets when the assets are sold. 

  • Stocks 
  • Bonds 
  • Real Estate 
  • Mutual Funds 
  • Private Equity 
  • Alternative Investments 

Tax Later – taxes are due when the funds are withdrawn from the asset. 

  • Qualified Plans 
  • Annuities 
  • Traditional IRAs 

Tax Never- funded with after tax dollars allowing for income tax free cash flow. 

  • Municipal Bonds 
  • Roth IRA 
  • Section 529 Plans 
  • Corporate-lite Cash Value Life Insurance 

Just like investment diversification, tax diversification should be a part of any financial savings plan.  As part of a risk management assessment, Cedar Point Financial Services LLC walks clients through how taxes impact yields and what tools may be available to mitigate taxation. 

It is Difficult to Save 

Some tax relief is found with qualified plans, but contribution limits and discrimination testing of these plans create a cap on how much can be saved.  Then, participants are faced with harsh taxation on distributions down the road.  One type of qualified plan, a Roth IRA, is more efficient and grants both tax-deferral and tax-free distributions, but only for those couples earning under $228,000 a year, leaving many back at square one, whiletrying to figure out how to protect their savings from tax erosion.   

Once qualified plan contributions are maxed-out, it is common for additional savings to be directed to brokerage accounts, where taxation is current and creates drag on performance.  Recognizing this inefficiency, some savers allocate after-tax savings to cash value life insurance, a tool that has long been used to effectively minimize taxation, provide tax-efficient growth, and tax-free income.  With over three decades of working with clients concerned about saving enough for their retirement years, Cedar Point Financial Services LLC can demonstrate how the tax benefits of cash value life insurance can create tax alpha. 

The Role of Cash Value Life Insurance 

Affluent individuals face distinctive challenges when segmenting asset classes, where all tax-advantaged asset classes are either unavailable to them or have limited value in their portfolio.  As previously stated, qualifying for a Roth IRA is extremely unlikely for high income, high net worth clients and funding limits of qualified plans restrict the percentage of wealth which can be allocated.  At the same time, these individuals typically have more highly concentrated allocations to very tax-inefficient investments like private equity, hedge funds and real estate.  It comes as no surprise that the ‘Tax Never’ zone strategy of using cash value life insurance to balance their tax diversification strategy can be extremely compelling. 

Individuals are discovering what major institutions have known for some time – cash value life insurance possesses unique tax benefits which can be positioned both as a contingent asset class to balance risk and return in a portfolio as well as to act as an effective tool for tax diversification.  These institutions have been targeting the ‘Tax Never’ category by allocating capital to life insurance for years.   

The allure of life insurance goes beyond the time tested and well-recognized benefit of tax-efficient growth of a policy’s cash value.  During lifetime, a cash value life insurance policy is a preferred source of liquidity on par with cash in a checking, saving or money market account.  When structured as a non-modified endowment product (“non-MEC”), after as few as three annual premium payments, a policy’s cash value can be accessed in the form of extremely low interest rate and tax-free loans which remain tax-free as long as the policy remains in-force. 

The tax-free nature of policy loans means that the after-tax rate of return to the policyholder is expected to be similar to after-tax returns of other assets bearing greater investment risk,  thereby providing tax diversification.  At Cedar Point Financial Services LLC, our clients understand that one of the best benefits of cash value life insurance is that when there is a need for cash, instead of being at the mercy of banks and other lenders with predatory rates and conditions, policyholders can leverage their own life insurance assets to access cash for personal and/or business needs.   


The Power of a Corporation 

In the 1990s, life insurance companies began designing cash value life insurance policies exclusively for use by public companies and large privately held ones.  Known as Corporate-Owned Life Insurance (COLI), companies started buying policies on thousands of their employees in order to tax-efficiently grow cash to fund a variety of employee benefits.  Life insurance companies were able to make concessions on policy pricing and to reduce or eliminate surrender charges and other fees as these corporate buyers allocate tens of billions of dollars on premiums each year. 

Fast forward nearly three decades and this institutional design and pricing is now available to individuals for use in their personal planning.      As an additional bonus, federal legislation signed into law in late 2021, changed the statutory definition of life insurance in favor of those policyholders who maximize contributions to cash value life insurance.  Under most circumstances, policyholders of cash value life insurance policies are now able to place more premium into their policies, sometimes upward of three times as much or more, for no additional life insurance costs without adverse tax consequences. 

Cedar Point Financial Services LLC can create tax diversification strategies using cash value life insurance, including corporate-lite policies based upon a broad array of criteria:  annual contribution budget, time horizon, risk tolerance, desired distribution timing, etc. 

Allocate to “Tax Never” Today 

Tax rates will undoubtedly vary over time, making it difficult to accurately plan for the future using strategies that either ‘Tax Now’ or ‘Tax Later.'  The ‘Tax Never’ attribute of cash value life insurance removes this uncertainty while allowing a policyholder to keep more of what they have set aside.  It is never too early to commit to tax diversification and immediately benefit from a reduced effective tax rate by allocating a portion of cash to the ‘Tax Never’ category asset of cash value life insurance.  The team at Cedar Point Financial Services LLC helps our clients develop plans to tax-efficiently maintain their lifestyles and protect their legacies.