When I was in my early 30s, I was living in Las Vegas and one of my friends was an insurance salesman. He had come to my office and started talking to me about disability insurance. At the time, I was very uneducated on disability insurance. It had always been my belief, especially as a CPA, that there was not going to be a time where I could become disabled and really claim those benefits. What was the worst thing that could happen to me? Maybe a paper card or I fall off my chair some way, there was really not this high risk of getting injured.
Much of what I had heard from other people was that policies that were purchased by CPAs, oftentimes, they were unable to use them because the nature of their disability claim is completely against disability insurance. Out of respect for my friend, and a desire to help him, I ended up buying the insurance, not knowing fully what I was getting into, believing that at some point I would just cancel that insurance.
You can imagine that multiple years later, I came to find out that I had a condition that one day would have caused me to be disabled for a period of time and maybe for even years. As a result, I started doing more research, and I realized that what I had bought was a great product to help me, and in fact, in 2019, I had a kidney transplant during that period of time. I was able to rely upon this insurance to help me and my family.
Well, why do I tell you this story? Because I believe for many of you, life insurance is the same way. You’ve had either bad experiences with a life insurance salesman, you’ve heard information from maybe some of the mainstream financial planners out there, and you’ve concluded that insurance is not right for you. I’m here to tell you that, if done correctly, life insurance can be a very important part of your retirement. It can also be a great way to transfer assets if you want to your beneficiaries or to some type of charity. We’re going to be talking about the life insurance retirement plan.
The life insurance retirement plan is a permanent insurance policy that is put in place, not necessarily for the death benefit, although there is a death benefit available, but the primary purpose of the life insurance retirement plan is to provide tax free income during retirement. It’s going to be a part of your regular income stream once you hit your retirement years.
Why do we use a product like this? Because in retirement, you need to have multiple streams of tax free income if you want to eliminate tax rate risk during retirement and if you want to eliminate many of the other risks that we talked about in our last week’s blog that are facing your retirement. A life insurance retirement plan can be a great way to do this. However, one of the important things that you need to understand about the life insurance retirement plan is that it’s very similar to getting married.
For those of you who have been married or for those of you that have attended a wedding or had a family member that’s gotten married, you know, it’s a very important time and that when people get married, the intent is for that marriage to last their lifetimes.
Unfortunately, because of many circumstances, and for some people, they would be grateful that the marriage didn’t last. Sometimes marriages don’t last. When that happens, what we find is that, for most people, it’s very expensive to get out of the marriage. Although it was very easy to go get a marriage license to get together, once it comes time for the divorce, it can become very expensive. Life insurance retirement plans are structured somewhat the same way. You need to look at these as a lifetime investment. The longer you can keep these plans, the better they’re going to be for you in your retirement. Life insurance shouldn’t be shocked every three to five years. If you do that, you’re going to lose money to fees that are going to be eaten up by the insurance company.
When you get into a life insurance retirement plan, again, realize that it’s for life, and it’s something that you want to have in place for a long period of time. There are three different types of life insurance retirement plans on the market. One of the things that you need to understand about permanent insurance is that you’re buying a section of term insurance, or you’re buying some insurance, but a lot of your money is going into a cash account or an investment account. This account is going to build up. It’s going to be used to help reduce the amount of insurance you need to buy during your older years when insurance can become very expensive. It also is going to be used to help fund your retirement if set up correctly.
The first type is what we would call whole life insurance. This is where your investment portfolio is invested in the insurance company. Now, this is not the policy that I would recommend for most people to use for a life insurance retirement plan. If you’re trying to get death benefit, maybe this is a great investment for you, but when you’re trying to get income, one of the biggest issues that we have with whole life insurance is that it is not productive and not very safe. What we find is that it’s not growing fast enough to accumulate the cash value that you need.
The second option is a variable of a universal life insurance policy. These are stock market policies where you’re investing in the stock market. With that, you have all the ups and downs that come with the market. These are not on the top of my list for recommendations for a life insurance retirement plan either. There’s too much volatility. In these types of life insurance investments, your assets are subject to the market, and when the market goes up, that’s great for you. When the market drops, like we’ve seen so many times over the last 20 years, it requires you to buy additional insurance, and it also means that you have less cash value inside of the policy, which can create problems.
The third option is the indexed universal life insurance policy.That’s the main one I recommend if you’re putting together a life insurance retirement plan. The indexed universal life policy is tied to indexes.
That means they have a floor and a ceiling. If you were to invest money into an indexed universal life policy, your cash value, if the stock market was growing, would go up, but it would have a cap. Let’s say that the market went up 20%, and your cap is, maybe, 12%. Then you’re only going to get 12%. Well, if markets were to always go up, it would be foolish to put money into this type of investment.
Unfortunately, markets don’t always go up. There are many times they go down. In fact, in 2020, there was a period of time that the market was down, over 20%. However, if you have an indexed universal life policy, you also have a floor. Instead of going down, then 20%, you would have dropped to zero, and that would have kept ,so you would not have lost money beyond zero. It would not have gone down, which would not have created the problems with volatility that we often have with these other products.
This is why I’m such a big fan of indexed universal life. Over time, it becomes a great place to put money that can then grow and use later for your retirement as a source of income.
Now, what are some of the key benefits that a life insurance retirement plan has? I want to make sure you understand these. The first one is there is no pre 59 and a half penalty.
If you were to put money into this plan in your 20s or 30s, and the cash value was to grow to a million or $2 million, you could pull that money out at any time without having a prepayment penalty. You don’t have to wait until age 59 and a half. The second one is there is no 1099. 1099s are the forms that companies provide you to report to you and the IRS that you have some form of taxable income. A life insurance retirement plan grows tax free. There’s no annual reporting to the federal government on your earnings.
The third one is distributions are not reportable income. Not only do you have access to tax free growth, you also have access to tax free distributions. You’re able to pull money out of these plans without having to pay tax.
Number four is there’s no contribution limits. Contribution limits means that you can put as little as 50 dollars a month in these plans, or you can put as much as $800,000 a year based upon your facts and circumstances.
Instead of like a Roth IRA or a Roth 401k, where you have limits, you’re able to contribute much more into this plan to allow for tax free growth and tax free distributions.
The fifth item is there’s no income limits. If you’re familiar with the way a Roth IRA works, you realize that Bill Gates could not contribute to a Roth as he makes too much money, nor could my wife, who makes no income, contribute to a Roth IRA. However, with a life insurance retirement plan, there are no income limits. Whether you make no money or you make millions and millions of dollars, you can still contribute to these plans.
The sixth and final item is there’s no legislative risk. If you go back to 1980, to 1984, and 1988, the IRS tried to change these plans, realizing that they were offering substantial benefits to people that maybe were too good, that things needed to be adjusted each time. As they came in, there were adjustments made.
Anyone who had these plans in existence prior to those dates were grandfathered in. They were able to keep the plans as they had them established. It’s my belief this will continue to happen. Not that they won’t make changes in the future, but that if you’re in a life insurance retirement plan, prior to them making the change, then you would not be subject to the legislative risks that are ahead.
We’ve talked about the key benefits, and these are all great benefits to help you. The other thing you need to understand is there’s a laundry list of requirements that your life insurance retirement plan should have, just like your marriage. I assume that, for most of you who have been married, you had a list of qualifications that you wanted your spouse to meet. There were things that were important to you and getting married, because you believed if you were able to match those up, you would have a far greater success of staying married and of enjoying the time you had together in your marriage. With a life insurance retirement plan, it’s the same way. There’s a list of things that you need to make sure your life insurance retirement plan has, or it’s not going to work the way that you expect it to.
The first one is safe and productive growth. That may seem like an oxymoron, but again, remember with the floor and the ceiling, you’re able to get upwards to 12 to 15% return, so it’s productive. It’s also safe. You’re not going to have to deal with all the down periods of the market, which if you were to look at any retirement plan, if you’ve got down years in the market and you’re having to pull money out, especially during the first five to 10 years, it can cut your retirement asset life in half.
The second one you need to be aware of is the low fees. When I talk about low fees, I’m talking about fees that are equivalent to any other type of investment that you would have during your retirement if you go out to many financial planners.
What you’re going to find is that the average fee most of them charge to manage mutual funds is somewhere around 1.5%. When we talk about a life insurance retirement plan, be aware that over the life of the policy, it is very important that you stay under this amount, or that you stay somewhere close to here. There are many policies out there that will allow you to stay inside of this fee structure. You need to understand that they operate differently than a typical investment. The reason being is because life insurance retirement plans are going to have higher fees up front for the first five to ten years. Then once you get to the end, they’re going to have substantially lower fees.
As you average them out, what you find out is that not only are you able to invest at the same rate that you would into a mutual fund, but you’re getting some additional benefits that are very important to you. One of those is a death benefit. This is why you’re paying fees upfront that are higher than you would put into a mutual fund because you immediately have a death benefit.
Another one is you also are going to have a long term care rider. We’ll talk more about that here in a minute. These are big benefits that are important that you have. A third item that you want on your list for your life insurance retirement plan is tax free and cost free distributions.
When you have a life insurance retirement plan, what you are doing is pulling money out of your own cash value account. As long as everything’s been set up correctly, and you don’t end up liquidating the account, you don’t over distribute, you will have tax free distributions. Many life insurance companies out there want to charge you to borrow your own money. It’s very important that you get hooked up with the right insurance company, so this doesn’t happen because when it does, it can cause you to pay hundreds of thousands of additional dollars that you do not need to pay to the life insurance company. Make sure as you look at your own life insurance, that you’re getting a structure of where and when you take out distributions, and you’re not paying slips amounts of money to do so.
The fourth and final one is cost for a long term care rider. Many life insurance companies realize that when you get to retirement age, the last thing you necessarily need is life insurance unless you’re trying to pass on a death benefit. Most people realize that they have the assets they’ll need to continue on throughout their life or the life of their spouse. These insurance companies, realizing that this was a problem, added a benefit to help address the biggest issue facing most people’s retirement, and that is long term care.
Many people don’t realize that if you live that life expectancy, your chance of needing long term care insurance in some form is 70%, that you have a 70% chance of having a long term care event. These companies came back and said we will provide you with a long term care rider, so if you have a long term care event, rather than waiting until you die to take advantage of the death benefits, we will provide those to you throughout your lifetime.
Now they’re each structured differently, but most of the good ones will allow you to take up to 25% of your death benefit in a given year to help you cover those long term care costs. This is a big benefit for the cost that you’re having to pay for this term insurance that you’re having to buy.
As we talk about these policies, when we talk about life insurance retirement plans, be aware that it is something that I believe every retiree needs to consider. You may be in a situation where your health does not allow you to get insured. If that’s the case, again, realize that our planning is not about one product. It’s about multiple streams of tax free income. You can still look at other planning options to help get yourself to where you need to be in retirement. If you do qualify and if you are rated correctly, this can be a great way for you to take excess money and put it into a tax free environment, especially when we believe taxes are going to go up and go up substantially in the future.If you don’t believe that, all you’ve got to do is look around and realize that our debt is spiraling out of control. We’ve got so many retirees coming on to Social Security and Medicare, that we have a financial problem that some point is going to have to be dealt with.
With the government cutting spending or increasing taxes, the probability of them cutting spending is not very great. The probability of them increasing taxes is pretty good because that’s what many of the politicians are already saying needs to be done to correct our financial situation.
Again, as you look at your own retirement plan, please make sure you consider the role that life insurance companies and especially life insurance retirement plans or permanent insurance policies can play in your future planning. These can be a very good asset to help you eliminate many of the risks that are facing your retirement and to get you to a more safe and secure retirement, so you can get safely home and that you’ll be able to run out of retirement before you run out of retirement assets.