Financial PlanningRetirementTax Planning

What the heck is a 501(k) plan?

The financial services industry has a long history of creating new marketing terms to help sell its products. Certainly this is a productive and useful part of consumer financial service communications. The latest term gathering attention is a “501(k) plan”. The increased use of this term coincides with marketing of an already existing alternate tool meant for relatively safe and conservative tax-advantaged wealth accumulation. This blog post is a list of my own observations about the recently popular term “501(k) plan”.

  • The term 501(k) as used here does not refer to a section of the Internal Revenue Code (as does the 401(k) plan).
  • There is actually a IRC 501(k) in federal tax law but that code section has nothing to do with the way that the term “501(k) plan” is used in financial services marketing today.
  • The term refers to the use of low-load and presumably high performance permanent life insurance as a superior alternative to traditional retirement plans.
  • A 501(k) plan document is often not required by IRS or state tax authorities but may be advisable or required for other purposes.
  • The term “501(k) plan” is not trademarked. It is used generically in this discussion to refer to a type of cash value life insurance plan designed to maximize cash value and the rate of return on investment using any insurance company’s life insurance products.
  • The strategy is not new, it has always been used by high income individuals and businesses.
  • The underlying strategy does have strong merit. This approach should be considered in conjunction with comprehensive tax and financial planning. Cash value life insurance does have many advantages.
  • Cash value life insurance, properly  designed, has tax advantages over traditional retirement plans.
  • Cash value life insurance is safer than many other types of investments.
  • Cash value life insurance, properly designed, provides asset diversification away from traditional stock and bond accounts.
  • Cash value life insurance, in some cases, will outperform the rate of return on traditional retirement plans.
  • The new Tax Cuts and Jobs Act law adds additional incentives to use this strategy. We should expect to see the use of cash value life insurance expand in financial planning as a safer alternative to traditional investments.
  • Years ago I investigated no-load life insurance, along with other advisers and financial service writers, and I concluded and reaffirmed the widely held opinion is that the no-load life insurance products were not “the best in the business”. In other words, companies were ‘pushing too hard’ to promote a no-load product and losing focus of overall performance. Instead, a low-load policy from a top mutual life insurance company is likely to give overall better results. That conclusion appears to be valid today.
  • The life insurance industry says that its products are “sold, not bought”. That is par of the reason that we don’t find much information online on this topic.
  • Ted Benna, the “father of 401(k) plans”, is credited with development of the 401(k) plans in the 1980s. He is now endorsing the 501(k) marketing plan. Mr. Benna was generous with his time as a business mentor when I opened my first financial planning office in 1987 in Doylestown.  I haven’t had any contact with him or his firm since leaving Doylestown in 1992. I have no idea why is supporting this marketing program that strikes me as gimmicky.
  • I do sometimes rely on this same strategy in clients’ financial plans – usually after other strategies have been fully implemented – but I do not use the 501(k) term to describe it. This is only one of many available tax saving and wealth building tools and there is no reason to consider outside of the scope of an overall financial planning strategy.

The best way to learn more about this strategy is to revisit your personal and business tax planning strategy and overall financial plan. Consider you age and health and try to make a realistic forecast of the number of years you expect to provide retirement income. Consider all the tax planning options available in light of your own goals and expected cash flow. If this 501(k) strategy is viable, it can easily be adapted to fit a specific financial and tax plan.

 


I recommend that investors should consider this strategy only after first evaluating the costs, risks, and comparative benefits of other strategies. A comprehensive tax plan and overall financial projection is the best way to estimate your tax results. It is important to get advice separately from the marketers of this or any financial service offering. I am pleased to introduce an affiliated fee-only financial adviser and a mutual life insurance firm that, in my opinion, offers the best combination of investment product value through their independent representatives. At your option, I can either provide either independent evaluation of this plan (at your expense) or affiliate support (I’m paid part of their fee) for the 501(k) plan work.

4 thoughts on “What the heck is a 501(k) plan?

  1. Individual life insurance to protect sps and children should be bought as TermLife, not as the lousy investment called Whole Life. Any planner should make that crystal clear.

    1. Thanks for the feedback. I am aware of this strong emotional position but sometimes I see another side. For example, my clients’ feedback is sometimes different. Earlier this month, for example, a good client asked advice on alternate insurance proposals completely unrelated to tax planning (and not related to this 501(k) concept) but before I could respond she laid out a strong argument why a smaller paid up whole life policy made more sense for her current situation. I agree with the logic although this is one case not every person.
      I’ve purchased both term and whole life as a young man for family protection. The term policy had a higher amount ($250,000 which meant a lot more in those days) and a much smaller whole life policy. The term insurance is now expired since it became unaffordable but the whole life is now fully paid and gives me back a decent dividend each year. I don’t need the cash dividend so it goes to buy more paid up insurance so that the policy amount increases each year. If I live long enough my heirs or creditors!) will receive almost as much as the term policy amount. I see that policy as an important and safe part of my core personal finances. I’ve calculated the return on investment as somewhere around 2% or 3% which is not impressive but it is a higher than my real local estate has returned over the past decade. (Here in South Jersey we are still down in value since the recession).

      This topic seems that just like politics, there are extreme viewpoints on either side. I tend to try to run down the middle. If I had my chance to do it all over again, I would still use a combination of term and whole life.

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