Bert Salazar, Managing Member Although there are a number of critical issues in retirement and income distribution planning, no issue is greater than the nemesis of taxation facing Americans in the future – this white paper will identify and address the issues of retirement taxation and how to safeguard all income assets from tax erosion throughout the three decumulation stages of life.

C a m b r i d g e F i n a n c i a l P a r t n e r s , L L C 2 0 0 0 P o n c e D e L e o n B o u l e v a r d S u i t e 5 0 0 C o r a l G a b l e s , F L 3 3 1 3 4

 

How to Create a Tax-Free Retirement Life

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How to Create A Tax-Free Retirement Life

I. Introduction: Our firm specializes in creating tax-free retirement plans for qualified clients in our practice – more importantly, we’re one of the very few firms in South Florida that truly addresses retirement income from a risk management and tax-advantaged perspective. As an Economics Advisor, I don’t advocate and/or give expert advise on tax matters, but we do depend on our affiliated tax partners for assistance in all tax planning objectives. Taxation in retirement can make or break a retirement plan success for many Americans today – many of the clients I encounter have most and/or all of their assets in taxable or tax deferred accounts – Ed Slott, famous CPA in the United States stated that “If you have taxable assets, you have a problem…and the problem is that you have assets that are forever taxed as opposed to never taxed”1 – Ed Slott truly understands the difference between making money and building wealth. Along the way, these same clients are working hard to have their mortgages paid off and to hopefully live in a debt free society. Here’s a simple yet important question for you:

During retirement, what percentage of your income would you like taxed?

If the answer to this question is 100%, please stop reading this white paper immediately – if not, you will find the next several pages fascinating and refreshing. Additionally, you will realize that most of your financial advisors have never discussed and/or planned your financial future from an economic perspective while performing deep-dive tax planning on your behalf – you deserve better than that!

II. Do You Believe in What We Believe In everything we do at Cambridge, we believe…

Ø In challenging our clients in areas of wealth accumulation and wealth distribution strategies Ø In creating cash flow income that is exempt from the IRS code Ø In creating a process whereby our clients pay taxes on their money only once Ø In creating maximum protection for life, income, and assets

                                                                                                               1  Ed Slott – The Retirement Savings Time Bomb, 2003

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How do we do it…

Ø By utilizing the IRS code to its maximum potential Ø By using products that are afforded the highest levels of tax benefits under the 74,000 plus pages of the IRS

code Ø By creating economic straddles that assist our clients in maximizing income and assets while minimizing and/or

avoiding potential tax liabilities in retirement The Cambridge Value Proposition… According to Marcus Lemonis, famous TV star of The Profit on CNBC, the success of every business and/or any business decision is based on the following diagram:

At Cambridge, we follow the same premises and understandings as Marcus Lemonis – It is all about People, Process, and Product, but although all three are critically important, the Process supersedes the other two – the reason is simple yet quite complex. The right people and the right product will not generate true-measured success if the process is flawed, yet the wrong people and the wrong product will create true-measured success regardless of people and product as long a the process is flawless – a sharp knife in the hands of an unskilled surgeon can kill you; a dull knife in the hands of a skilled surgeon can save your life. III. Forecasting the Future of Taxation in the United States

As many Americans are gearing up for retirement and longevity planning, the U.S. economic challenges will play a major role in whether these Americans will reach and/or attain a comfortable retirement in the foreseeable future. For example, the U.S. National Debt is currently at $19 trillion2 and counting! In 2015, the U.S. spent $223 billion, or 6% of the federal budget, paying interest on the federal debt3. According to the Social Security Board of Trustees, Social Security will become insolvent by 2033 unless Congress makes major changes to its current program – some of those changes may include the link of cost of living increases to different inflation indexes, increasing full retirement age to 67, increasing or eliminating wage cap for payroll taxes, increasing payroll taxes, or a combination of all these options4. In addition to Social Security issues and concerns in the 21st Century, Medicare and Medicaid issues are much worse – the unfunded liabilities for Social Security, Medicare, Medicaid, Medicare Part D, and Obama-Care (Affordable Care Act), exceed $100 trillion dollars!5

                                                                                                               2  U.S. Debt Clock.org 3 Fix the Debt – Info@Fixthedebt.org 4 2014 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds  5  U.S. Debt Clock.org  

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The U.S. Debt Clock shows that each tax-paying American owes the government $161,651 today just to cover the national debt – on the other hand, each tax-paying American owes $858,668 today to cover the unfunded liabilities previously discussed. Since these numbers appear so farfetched to most Americans and the majority of my clients, let me explain the difference between $1 million, $1 billion, and $1 trillion in simple terms – one million seconds ago was 12 days ago; one billion seconds ago was 32 years ago; one trillion seconds ago was approximately 32,000 years ago, and humans were barely roaming the earth – do you get it now? Do you see why political pundits refuse to address and/or acknowledge this problem on either side of the aisle – Where do you think taxes will be in the future? Higher, lower, or will they remain the same? David M Walker, CPA Comptroller General of the United States and former head of the General Accountability Office (GAO) stated that “based on current fiscal path and economic policy, future taxes will have to double or our country will go financially bankrupt”6. Moreover, by the year 2020, 92 cents out of every revenue dollar for the U.S. government will go toward Social Security, Medicare, Medicaid, and the interest on the national debt – again, where do you think taxes will be in the future? As a footnote, the average marginal federal income tax bracket in the United States has been 62% since 1926, and the top federal income tax rate never went below 70% from 1936 to 1981. IV. Deductions, Deductions, Deductions Most of the clients we engage in our firm have done a fairly good job in maximizing their annual deductions, yet by doing so, they have created numerous booby-traps that will surface in the future and will prove devastating to their wealth building planning capabilities. Interest on loans to purchase investment properties, interest incurred in the conduct of your trade or business, and qualified residence interest are fully deductible interest based on current law – traditional credit card interest used for personal expenses are not deductible at this time. Qualified residence interest is divided into two distinct parts: Acquisition Indebtedness and home equity indebtedness. Acquisition indebtedness comes into play when purchasing a home and/or making substantial improvements to a qualified residence. The limit on acquisition indebtedness is $1,000,000 for married persons filing jointly or $500,000 for married persons filing separately. Home equity indebtedness comes into play when taking a home equity loan that may be above or beyond acquisition indebtedness. The limit on home equity indebtedness is $100,000 for married persons filing jointly and $50,000 for married persons filing separately. Other deductions like qualified education loans are available but they do contain income phase-out requirements for many Americans7. In addition to all above-depicted interest deductions, tax filing Americans benefit from the traditional standard deductions – The 2016 limit on standard deductions is $12,600 for married persons filing jointly and $6,300 for single or married persons filing separately. Moreover, the personal exemption amount for 2016 is $4,050 but there are phase-out income limits as well. For married persons filing jointly, personal exemptions begin to be phased-out at $311,300 and are fully phased-out by $433,800. For single persons, personal exemptions begin to be phased-out at $259,400 and are fully phased-out by $381,900.

V. The Importance of Tax-Free Income in Retirement

The future of taxation in the United States is quite bleak and uncertain! As a matter of fact, the U.S. Debt is increasing by approximately $2.5 billion daily and there is no relieve in the foreseeable future. Therefore, the ability to manage taxation

                                                                                                               6  The U.S. Deficit and Debt – David Walker in, Comeback America 2010 7 The Pirates of Manhattan – Barry James Dyke Copyright 2008  

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in retirement is more prevalent today then at any other time in our history – yes, as a country, we are living in the 3rd lowest tax assessment levels in history except for the periods during the introduction of the Internal Revenue Service in 1913 and the Great Depression years of 1929 through 1939. Since taxation and inflation provide the largest eroding factors to wealth and income planning, having the ability to avoid taxation at retirement enhances and boosts an incremental leverage of retirement income and wealth creation at the most critical time in a retiree’s life – remember, inflation is not tax deductible, and thus, most retirees feel the obligation to take additional risk with their money in retirement in order to offset the loss of purchasing power due to annual inflationary rates and/or increases. On the other hand, by avoiding taxation altogether, retirees can play it safe with their hard-earned retirement dollars thus avoiding ill-wanted investments throughout a lifetime of income distribution and/or income depletion.

VI. How’s Your Money Taxed There are four distinct tax segmentations boxes in the IRS Code. As an Economics Advisor, it is critical that my clients are fully aware of what these boxes are and how they work – only then will they see the advantages and disadvantages of each of these tax segmented boxes. The following diagram depicts the segmentation of how taxes are paid in the U.S. in relation to specific investments:

As you can see from the above diagram, the top left tax segmentation box (TTT) provides the least amount of tax benefits, yet it provided the highest liquidity since everything in that box is taxed on an annual basis and thus provides liquidity (contributions have been taxed; annual interests earned has been taxed; and asset liquidation has been taxed at ordinary income and/or short-term capital gains rates). The bottom left tax segmentation box (TDT) provides certain current tax protection by allowing the incremental accumulated interest of the investments to grow on a tax-deferred basis. Due to the fact that the IRS allows that interest and/or gain to accumulate on a tax-deferred basis, this tax box contains and IRS handcuff called the 59½ Rule – other than real estate assets and/or individual held stocks, the IRS dictates that if an early investment distribution is made out of this box prior to age 59½, not only does the investor need to pay the distribution tax based on his/her federal income tax bracket, but said investor must also pay an additional 10% penalty for early distribution – this tax box is primarily used for long term and/or retirement supplemental investments. The bottom right tax segmentation box (DDT) is fairly known by most Americans – this is the qualified plan box and this is the area where the majority of assets reside for most retirees in the United States today. According to several known tax publications in the U.S., there are approximately $5 trillion in qualified plan asset investments with major wire-houses, mutual fund companies, and insurance companies. Moreover, since the IRS allows for pre-tax contributions along with tax-defer growth in this tax box, not only does the IRS place the traditional 59½-rule handcuff on this box, but they also place a 70½-rule handcuff on this box as well. Basically, the 70½-rule is the Required Minimum Distribution Rule (RMD) which forces mandatory distributions out this account at 70½ regardless of investor’s needs and/or desires. Failure to take the mandatory distributions at 70½ places a non-distribution penalty in the amount of 50% along with the investor’s distribution tax based on his/her current federal income tax bracket.

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It is important to note that this qualified plan tax segmented box (DDT) does not provide tax savings as many pundits claim; it only provides tax-postponement! Most important, when you postpone the tax, you also postpone the tax liability (making a financial bet on something you can’t control is what I call Catastrophic Speculation). The top right tax segmentation box (TDF) is the least known tax box by most Americans, and it is the one I will be discussing today in this white paper – this tax segmented box contains some and/or all of the liquidity features of the (TTT) box, yet it enjoys the tax benefits of the other tax boxes as well, except for one major difference – proper distribution out of this tax segmentation box is federal income tax free to all investors and/or retirees! Let me repeat…proper distribution out of this tax segmentation box is federal income tax free to all investors and/or retirees! Now, Roth IRAs and Roth 401ks contain the 59½ -rule previously depicted in the (TDT and DDT) boxes, but Roth IRAs do not contain the 70½ (RMD) rule, and although the Roth 401ks contain the 70 ½ (RMD) rule, the investor and/or retiree can rollover the Roth 401k assets to a Roth IRA asset and thus avoid the 70½ (RMD) rule requirement. Nevertheless, distributions from Roth IRAs and Roth 401ks are received federal income tax free. As I conduct Economic models for new and existing clients, I notice that most of their assets are located in either the (TTT) box or the (DDT) box – for obvious reasons, there is an incremental disparity between all four tax segmented boxes, and this creates an unwarranted compounded effect on current and/or future taxes. Understanding Provisional Income financial and tax calculations is paramount in order to mitigate these disparities – think of it this way…as an American farmer, would you rather pay taxes on a few bushels of seeds, or would you rather pay taxes on truckloads of wheat? From an Economics perspective, this (TDF) tax segmentation box offers tremendous benefits to investors and/or retirees that none of the other boxes provide:

The (TDF) box provides…

Ø The most efficient wealth building box in the tax model Ø The most creative leverage box for income and wealth in the tax model Ø The best positioned tax box for wealth creation and/or wealth recapture Ø It provides and Economic multiplier effect which increases the velocity and/or efficiency of money Ø It is the most efficient tax box in the Economic model Ø Provides innovative financial freedom…taxes are paid on the seeds, not the harvest!

Successful economics is not about purchasing the best golf clubs in the world; it’s about having the correct swing and/or strategy, along with the keen ability to manage the golf course and/or financial world. VII. Understanding Provisional Income As I engage clients in the retirement planning process, I start with Provisional Income calculations – most Americans and many financial advisors have no clue as to what “Provisional Income” is and how it works – By definition, “Provisional Income” includes 100% of the earnings from employment, pension plan payments, dividends and interest from regular investments, withdrawals from IRAs and 401k plans, and interest from municipal bonds (muni bonds may be received income tax-free, but they do have a negative impact on Social Security benefits taxation)8. To this, you must add 50% of Social Security benefits received in that year in order to arrive at the “Provisional Income” total. For single individual or head of household, if the “Provisional Income” is less than $25,000 for that year, Social Security benefits are not reported as income for that year. If “Provisional Income” exceeds $25,000 but is less than $34,000, then up to 50% of Social Security benefits are taxable. In excess of $34,000, then up to 85% of Social Security benefits are taxable. For married couples filing jointly, the thresholds are higher and more forgiving. If the “Provisional Income” is less than $32,000 for that year, Social Security benefits are not reported as income for that year. If “Provisional Income” exceeds $32,000 but is less than $44,000, then up to 50% of Social Security benefits are taxable. In excess of $44,000, then up to 85% of Social Security benefits are taxable.

                                                                                                               8  U.S. Tax Code – Publication 915 – Social Security and Equivalent Railroad Retirement Benefits

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Historically, Social Security benefits9 and their taxation have become hot potatoes over the years – Here’s why:

Ø Franklin Roosevelt, a Democrat, introduced Social Security in 1935. Ø He promised that participation in the program would be totally voluntary. Ø That participants would only pay 1% of their first $1,400 of income into the program (today, participants pay

6.20% up to the annual increasing taxable wage base currently at $118,500 for 2016). Ø That participants’ contributions to the program would be tax deductible for tax purposes every year. Ø That participants’ contributions would be placed into an independent “trust fund” for the Social Security

Retirement Program exclusively (under Lyndon Johnson, a Democrat, the money was moved to the “General Fund” and spent).

Ø That the annuity Social Security payments to retirees would never be taxed as income (under Bill Clinton, a Democrat, up to 85% of Social Security benefits may now be taxed). The government giveth; and the government taketh away.

Therefore, it is critical for Americans to understand the impact of taxation in retirement, along with inflationary pressures that will attack all incomes in the future. What types of tax-free income are available in retirement, and which ones do not negatively impact Social Security benefits? Following you will find available tax-free incomes in retirement:

                                                                                                               9  Social Security – A Documentary History, 2006

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As you can see, there are only 4 vehicles under the IRS code that allow for tax-preferred retirement income – Out of the 4, only 3 allow for “Provisional Income” exemption (Roth IRAs, Roth 401ks, and Life Insurance).

VIII. Description and Features of Roth IRAs:

Ø Tax free growth of accumulated funds Ø Tax free distribution of accumulated funds Ø Limited contributions as allowed by law Ø No access to accumulated funds prior to age 59½ Ø No RMDs of accumulated funds at age 70½ - funds can remain in the account until death Ø No Social Security tax triggers (Provisional Income) Ø Credit protection in the State of Florida up to $1 million, but rollovers from a qualified ERISA plan offers

unlimited protection Ø Roth IRAs are creatures of the IRS code

IX. Description and Features of Roth 401ks:

Ø Tax free growth of accumulated funds Ø Tax free distribution of accumulated funds Ø Limited contributions as allowed by law Ø No access to accumulated funds prior to age 59½ Ø Required minimum distributions (RMDs) of accumulated funds at age 70½, but can convert to a Roth IRA in

order to avoid (RMD) requirements Ø No Social Security tax triggers (Provisional Income) Ø Credit protection in the State of Florida is unlimited (ERISA Plan) Ø Roth 401ks are creatures of the IRS code

X. Description and Features of Municipal Bonds:

Ø Tax free growth of accumulated funds Ø Tax free distribution of accumulated funds in residential state Ø Access to accumulated funds prior to age 59½ without penalties Ø No RMDs of accumulated funds at age 70½ - funds can remain in the account until death Ø It may trigger a Social Security tax (Provisional Income) Ø No credit protection in the State of Florida

XI. Description and Features of Life Insurance:

Ø Life insurance enjoys the highest tax benefits of any product in the 74,000+ pages of the IRS code Ø Every family member has an economic and fiduciary duty to protect the family unit for current and/or future

generations10 Ø Every person has an economic human life value that must be insured and utilized Ø The probability of death is 100% Ø The cash value can be accessed via withdrawals and loans on a tax-favored basis Ø There is no income tax on earnings if the policy is structured and correctly maintained Ø Provides liquidity for emergencies and/or strategic needs Ø The yield is above-average compared to other “fixed income” instruments Ø The asset is safe with guarantees (guaranteed death benefit, guaranteed cash values, and guaranteed premiums)

                                                                                                               10 U.S. Tax Code – Publication 915 – Social Security and Equivalent Railroad Retirement Benefits

 

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Ø The asset is available as collateral for business and personal loans Ø Credit protection in the State of Florida and certain other states Ø Flexible contract features and benefits Ø Contributions and/or premium payments can be flexible Ø No premium increases and premiums may be offset with dividend options Ø No maximum contribution limits as in qualified plans but there are insurability limits that may limit ongoing

contributions Ø No 59½ - rule penalties for early distribution as in qualified plans Ø No 70 ½ - rule penalties for delayed distributions as in qualified plans Ø Self completed plan in case of death, disability, or critical illness with proper insurance riders Ø Eliminates the need for term insurance and its related Loss Opportunity Costs Ø Enhanced tax benefits as tax rates rise in the future Ø Accelerated Benefits Rider offers access to death proceeds in case of chronically or terminally diagnosed

illnesses Ø Provides for Long Term Care Benefits through LTC riders Ø Income distribution at retirement can be tax-favored if properly structured Ø Not subject to stock market fluctuations losses on liquidation Ø Lifetime tax-favored income stream available with distribution options Ø No annual tax return filing and/or requirement Ø Not subject to ERISA, DEFRA, TEFRA, OBRA, or IRC 400 Series Government Regulations Ø Not subject to compliance penalties or fines as in qualified plans Ø No termination requirement hassles and/or obstructions Ø Simple to initiate (no attorneys, CPAs, or government approval required) Ø If corporate owned…not subject to employee scrutiny or publicity Ø No employee participation requirement Ø Not subject to annual actuarial studies and/or costs (unless in a qualified plan) Ø Contract holder can execute a life settlement for immediate cash if necessary Ø Distributions do not cause taxation of Social Security Benefits (Provisional Income) Ø Distributions do not cause higher Medicare premiums for higher net worth individuals Ø Contract can be utilized for business purposes to reward key employees with retirement incentives Ø Permission slip for Pension Maximization strategies that increase guaranteed retirement income Ø Contract increases spousal protection on a guaranteed basis Ø Contract provides for the recapture of lost Social Security income upon the death of one spouse Ø Contract provides for the pay-down of other assets if necessary in order to increase retirement income Ø Contract provides protection for Reverse Mortgage strategies at older ages Ø Contract provides for the highest internal, external, and eternal rates of return due to its guaranteed features Ø Collateral for private and/or business loans Ø Enhances the Volatility Buffer Concept at retirement Ø Contract may be assigned to a trust (revocable or irrevocable) Ø Fully eligible for the marital deduction Ø Not subject to probate Ø No publicity at death and increases estate growth on a guaranteed basis Ø Contract can be used to pay taxes on large IRAs and/or other qualified plan distributions thus enhancing the

stretch IRA options at death Ø Death proceeds are received in cash by all beneficiaries including trust…acts as money in escrow Ø Death proceeds are received federal income tax free and estate tax free if properly structured Ø Death proceeds can be received as a Lifetime Annuity Income stream if desired Ø Contract provides for payoff of personal and business debts Ø Provides a guaranteed asset for Special Needs (children or adults) Ø Death benefits can increase with dividend options and additional PUA rider deposits…keeps up with inflation Ø Allows for the recovery of all financial mistakes made during a lifetime Ø Provides needed cash to keep business afloat until suitable buyers are acquired Ø Replenishes dollars spent on medical expenses and/or nursing care Ø Full expression of love and concern to family, business, and designated charities Ø Finally, it allows the contract holder to die on the side of the angels

As you read through the description and features of the four tax-preferred income products in the U.S., did you notice that permanent life insurance possesses more benefits and features than Roth IRAs, Roth 401k, and Municipal Bonds

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combined…the answer is simple – life insurance is a social product and not a creature of the IRS code – life insurance has been around for almost 500 years and it serves as the core benefit and guaranteed protection of the family unit. XII. The Features of the Ultimate Retirement Plan

Ø Contributions to qualified plans should be limited to the match and/or no more than 7% of gross income Ø Qualified plan distributions should match the annual Standard Deduction during retirement Ø Traditionally, Standard Deductions have had inflationary annual increases Ø Maximum contributions to permanent life insurance, Roth IRAs, and Roth 401ks Ø Due to its leveraging, features, benefits, and tax effect, permanent life insurance should be at the center of all

economic planning Ø If taxes must be paid, then they should be paid at…capital gains rates

As you can see, a successful retirement plan requires the understanding and application of economic principles. This is what my firm and I do! As an Economics Advisor, I understand that methods are many, and principles are few; methods are always changing; yet principles never do. The golf clubs, swing, and golf course analogy previously mentioned applies to retirement Economics now more than ever – retirement success is about strategic design, economic straddles, taxation and inflationary control, income guarantees regardless how long someone may live, risk reduction and/or risk avoidance, transferring longevity and volatility risk to a 3rd party pool of risk managers, the calculation of Provisional Income scenarios years before they are implemented, survivor benefits and guarantees, netting, flattening, and pay-down concepts in order to reduce the negative impact of compounding taxes while increasing distribution and/or retirement income. Henceforth, retirement success is about a sound, structured, Economic Process in the hands of a skilled Economics Advisor – at Cambridge, we have the People, Process, and Products necessary to help our clients reach financial success in this volatile and unforgiving world. In summary, Americans need to be able to live and enjoy their wealth. By the same token, they must have legacy generational planning strategies in order to satisfy the needs, goals, and objectives of the family unit – The rich are always planning and thinking two or three generations down the line; the poor only think about their minimum needs while forgetting the family unit enhancement planning altogether. In the now famous book titled “The Economics of Life Insurance”11, S.S. Huebner wrote the following: “Man should be regarded as having two business enterprises, his home and his vocation. Of these the home is more important, the vocation serving primarily to afford the greatest economic advantages to the family business”. He also went on to say, “The basis of life insurance is the dollar value of human life – the factors of personal character, health, industry, education, training and experience, creative ability, and driving force and patience to bring about a realization of what the mind creates. Were it not for this value, there would be no property values. The human life value is the cause rather than the effect, the permanent producer rather than the temporary product”.

                                                                                                               11 The Economics of Life Insurance 3rd Edition, S.S. Huebner 1927

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The work we do at Cambridge assists our clients in changing the way they see things, because when they change the way they see things, the things they see change – if you believe in what we believe, then come join our economic and financial revolution today. Please check the diagram on the next page regarding our company’s business capabilities. Tomorrow is promised to no one… Bert Salazar, Managing Member Cambridge Financial Partners, LLC

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XIII. The Institution of Cambridge Financial Partners, LLC