Much of the conversation around retirement planning focuses on how much clients should save. But what is just as important is where they should save.
The reality is that very few Americans have a full understanding of the financial challenges that may impact their overall retirement outcome. Constant changes in our world, from geopolitical and regulatory to economic, require advisors to provide more comprehensive planning guidance than ever before and to explore how to protect wealth as well as grow assets.
In 2012, retired Americans received $1.1 trillion in income. Of that, according to the LIMRA Secure Retirement Institute (SRI) two-thirds came from Social Security and traditional pension plans (42 percent and 23 percent, respectively). When considering that the Social Security retirement trust fund is projected to become depleted by 2033, and only one in five Generation X and Generation Y households has access to a pension plan, helping clients diversify their retirement income sources is increasingly important.
There is an enormous opportunity for the life insurance industry to advance the client discussion about policy benefits beyond the death benefit, and to help them understand how cash-value life insurance can contribute to a well-rounded retirement portfolio.
Today, only 26 percent of pre-retirees (age 55 and up) and 21 percent of trailing-edge boomers (ages 46-54) own cash-value life insurance, according to LIMRA SRI. This means that the tax advantages and income flexibility that life insurance can bring to a retirement portfolio are currently not part of the plan for the vast majority of the population that will be retiring over the next 20 years.
With cash value life insurance, clients can potentially accumulate savings on a tax-deferred basis. Depending on the client’s specific needs and risk tolerance levels, that growth can be pursued through various products, such as variable universal life or indexed universal life.
Regardless of the type of cash value life insurance policy selected by a client, generally they all allow for the savings to be distributed income-tax free through policy loans and withdrawals (provided the policy is not a modified endowment contract). In addition to providing the client with greater purchasing power, the “non-income” categorization of the cash value distribution also means there may be little or no impact on income tax bracket or modified adjusted gross income, thus having potentially no impact on the taxation of Social Security benefits or Medicare Part B costs.
Often when determining retirement age, clients strongly consider how most efficiently to use their various retirement income sources, such as by avoiding early withdrawal fees on a 401(k) or preserving their full Social Security benefit. Today, with approximately 30 percent of nonretired Americans expecting to retire before the age of 65, cash value life insurance distribution can provide a cash stream for clients during the years before they can access their other retirement benefits without penalties.
Alternatively, those retiring at age 65 can use cash values as a source of backup income should they outlive their traditional retirement assets. Today, a man reaching age 65 can expect to live, on average, until age 84.3, while a woman turning age 65 can expect to live until age 86.6. Approximately 25 percent of 65-year-olds today will live past age 90. Cash value life insurance can help clients develop an income road map based on the good fortune of longevity that also allows them to transfer an income-tax-free death benefit to heirs if the income is not needed.
While increased longevity in retirement means more time to enjoy life, friends and family, it can also mean increased chances for unexpected events such as chronic or terminal illnesses. In these unfortunate scenarios, which can pose significant risk to a client’s assets while creating physical, emotional and financial burdens for loved ones, cash value life insurance can help alleviate some of the financial and caretaker challenges so that clients and families can spend time together and preserve the wealth they’ve worked hard to accumulate. Subject to client qualification, many cash value life insurance policies offer an accelerated benefits rider, at issue for an additional cost. This rider can provide a source of supplemental tax-advantaged funds that can be used for any expenses, including family/home health care, home remodeling, prescriptions or skilled nursing care.
Often when it comes to the distribution phase of a retirement plan, clients rely on their traditional retirement savings vehicles such as a 401(k) or individual retirement account to fund “needs” (mortgage, daily living expenses) and “wants” (entertainment, travel), while using retirement assets such as annuities and dividends to help cover some of the “wants” and “dreams” (vacation home, grandchild’s education). Clients can optimize this traditional planning model by taking advantage of the income flexibility available through cash value life insurance for some of the needs, wants and dreams, while leveraging the death benefit to fund a legacy.
When it comes to retirement planning, there is no silver bullet. There are many different considerations requiring a well-rounded portfolio of retirement assets. Cash value life insurance is often overlooked in the construction of such portfolios. Cash value life insurance is by no means intended to replace the staples of a retirement portfolio, such as a workplace retirement savings account such as a 401(k). Yet clients may be intrigued to know that it is the only solution with the potential to provide all the following benefits: tax-deferred growth; tax-advantaged distributions; no additional tax for early withdrawals; no increase in tax expenses, Social Security taxation or Medicare premiums; chronic illness coverage; and an income tax-free death benefit.
This is not to say there are no risks or considerations that advisors and clients need to take into account when evaluating cash value life insurance. Advisors and clients must consider product suitability, the potential for surrender charges, and underwriting and product logistics. However, advisors who can provide guidance on how to protect wealth through life insurance strategies will be able to help clients toward the retirement outcomes the clients desire.