Help Your Clients Visualize Tax Deferral

March 24, 2014

Explaining the power of tax deferral might be a concept that’s easier to explain with visual aids rather than verbal description alone.

As the father of a son who just turned two, I find myself trying various techniques to teach him as much as possible so he can fly successfully from the nest one day. As many parents can attest, it's sometimes easier "showing" kids how to do something rather than "telling" them to do it. I think the same is true for how some clients might be best engaged.

Explaining the power of tax deferral might be a concept that’s easier to explain with visual aids rather than verbal description alone. That's not to say some advisors in our industry haven't found success using verbal descriptions to discuss this concept with clients. Here in the Retirement Strategies Group, we feel that verbal descriptions by themselves may not do justice to this concept.

That's why Pacific Life developed tools to help visualize the power of tax deferral, as a strategy, to your clients.

The Rule of 72 and The Rule of 96

The Rule of 72 and the Rule of 96 are mathematical formulas that can help visualize the power of tax deferral. The Rule of 72 is a rule of thumb used to estimate how long it generally takes for your money to double in a tax-deferred account. The rule requires that you divide 72 by the expected growth rate to estimate the number of years it will take your money to double. For example, a tax-deferred vehicle like an IRA or a deferred nonqualified annuity growing at 3% would double in approximately 24 years (72 ÷ 3 = 24).

In contrast, the Rule of 96 estimates the time needed for taxable money to double, assuming a 25% tax rate and expected growth rate. Simply divide 96 by the expected growth rate to estimate the number of years. For example, a taxable account growing at 3% would double in approximately 32 years (96 ÷ 3 = 32). The table below illustrates the Rule of 72 and the Rule of 96 at work.

The Rule of 72 and Rule of 96 are mathematical concepts and are not illustrative of any products offered by Pacific Life.

Expected Growth Rate The Rule of 72
(Tax-Deferred)
The Rule of 96
(Taxable at 25%)
3% 24 Years 32 Years
4% 18 Years 24 Years
5% 14 Years 19 Years
6% 12 Years 16 Years
7% 10 Years 14 Years

1Note: Some numbers have been rounded to the nearest whole number.

Of course, it's important to remember that any tax due in a deferred vehicle is only "deferred" and not "exempt," so you need to take into account estimated final tax liability from the deferred vehicle as well. Thus, you would want to compare the estimated net after tax amount from the tax-deferred vehicle to the funds available in the taxable account to better form a visual comparison of the two scenarios.
 

The Pacific Life Tax Deferral Analyzer Tool

As a more custom-tailored approach to visualizing tax deferral, the Pacific Life Tax Deferral Analyzer tool (discussed in a blog posting last month) was developed to help advisors show clients the way tax deferral works through a report you can use with your clients.

These resources can be especially helpful following FINRA's stricter requirements that went into effect February 2013 for discussing tax deferral with the public.*

Although I may not be teaching my son anytime soon about tax deferral, you now have some tools at your disposal to help your clients understand this concept more clearly. For more information about the power of tax-deferred growth or the Tax Deferral Analyzer tool, contact the Retirement Strategies Group at (800)722-2333, ext. 3939, or e-mail us at RSG@PacificLife.com.

 

 

*FINRA Rule 2210(d)(4)(C)

Picture of Pacific Life Annuities

Pacific Life offers a broad and diversified range of products and solutions designed to help individuals and families achieve asset growth, sustainable retirement income, and long-term financial independence. We also help businesses manage and fulfill their long-term retirement plan commitments to employees.

Pacific Life, its distributors, and respective representatives do not provide tax, accounting, or legal advice. Any taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor or attorney.

Pacific Life is a product provider. It is not a fiduciary and therefore does not give advice or make recommendations regarding insurance or investment products.

Pacific Life refers to Pacific Life Insurance Company and its affiliates, including Pacific Life & Annuity Company. Insurance products are issued by Pacific Life Insurance Company in all states except New York and in New York by Pacific Life & Annuity Company. Product availability and features may vary by state. Each insurance company is solely responsible for the financial obligations accruing under the products it issues. 

Variable insurance products are distributed by Pacific Select Distributors, LLC (member FINRA & SIPC), a subsidiary of Pacific Life Insurance Company (Newport Beach, CA) and an affiliate of Pacific Life & Annuity Company. Variable and fixed annuity products are available through licensed third parties.

No bank guarantee • Not a deposit • Not FDIC/NCUA insured • May lose value • Not insured by any federal government agency