How much money do you think you'd have to earn per year to find yourself among the top 1% of American earners? Would you guess $1,000,000? $2,000,000?
Surprise - you'd only need to make about $421,926, including a spouse's income. If you already make more than that, you're in the top 1% of earners in the nation! If not, stick around because I'm going to explain how these folks manage their money - and share strategies you can use, too.
How Top Earners Categorize Money
When it comes to building wealth, there are three types - or "buckets" of money. Each bucket is taxed in a different way. These include: taxable (pay the tax now), tax-deferred (pay the tax later), and tax-free (never pay tax). Taxable money includes your salary, as well as stock dividends and interest earned. Tax-deferred money includes the money you put in traditional retirement accounts like a 401(k) or IRA. You get to fund that account with pre-tax money to help it grow, but you have to pay the tax later, when you start taking disbursements. Tax-free money includes money you put into financial products that don't incur a tax penalty at all. This includes Roth IRAs, municipal bonds, and some types of life insurance. The wealthy use financial strategies that let them put as much money as possible into the tax-free bucket. Luckily, this strategy works no matter how much money you have. There are always ways to make sure your money is distributed among all three buckets, with preference given to tax-free income strategies.
The #1 Challenge Top Earners Face
The majority of taxes - a whopping 84% - get paid by the top 25% of wage earners. That's the biggest problem top earners have. They want to protect their hard-earned money instead of paying it to the IRS. They're usually most worried about the tax increases that are very likely to occur by the time they're ready to retire. Tax increases are a seeming inevitability, based on the growing national debt, especially during and after the COVID-19 pandemic. The bulk of these tax increases will fall upon the people most able to pay - the wealthy.
How the Top 25% Protect Their Wealth
Wealth builders make the same decisions you and I make right now. They buy cars, start businesses, and put kids through college. But they use different financial tools to achieve their goals. They need different tools to do these things because they know how tax rates affect their wealth. While you or I might borrow money or save up to make a purchase, wealth builders are most likely to use collateral. They leverage their accumulated wealth to secure a loan with more favorable terms than they'd get from a bank. What makes the terms favorable? They make sure the interest rate on the loan is less than the percentage they earn from their investments. This means they're always generating a positive cashflow, even when they're borrowing money.
How Life Insurance Plays a Role
Now that you know what the main challenges and risks are to growing your wealth, let's get to the good stuff - the tool that helps you guard against these risks. You have access to the same financial tool that many of the wealthiest 25% of Americans use to protect and grow that wealth: cash value life insurance. Specifically, a form call IUL, or indexed universal life insurance. IUL is a type of permanent life insurance, which also includes a cash value account attached to your policy. In the early years of your policy, your premium payments help fund the cash in this account. It grows based on a rate of return specified by your insurer when you buy the policy. Here are some of the specific financial benefits of an IUL policy:
- Tax-free death benefit for your beneficiaries. As with all life insurance policies, your beneficiaries get a cash payout that's not taxable.
- Tax-deferred cash accumulation. While your cash value accumulates, you don't pay tax on that accumulation.
- Tax-free supplemental retirement income. You can withdraw money from your cash value account or take a loan against it. That income is tax-free.
- No penalties for early distribution. Unlike 401(k)s or IRAs, you can take a distribution from your cash value account before age 59 1/2 without a penalty. Plus, you don't have to take a distribution at age 70 1/2.
- Loan repayment built-in. When you pass away, your policy's death benefits will first go toward paying off any outstanding policy loans you have. The rest will go to your beneficiaries tax-free.
Ready to Use These Strategies Yourself?
As you can see, IUL helps wealth builders sock away money in that third tax-free bucket. Policy loans and cash value distributions are both tax-free, up to the value of your premium payments. This strategy works best when you start early, so that cash value has lots of time to grow and compound.
If you like the idea of having extra money available to you during your retirement, permanent life insurance may be your answer. You can protect your family during your lifetime, supplement your existing retirement fund, and transfer wealth to your heirs after your death...all with one financial product.
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This is general information and not intended to serve as legal, tax, or other financial advice. Please consult with your attorney and/or CPA regarding your specific situation.
Source for 1% stat: Business Insider, 2019.