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How Life Insurance Makes Millions for Retirement

Do you remember the last market decline?  We are sure you do – it was the Great Recession of 2008.
And it wasn’t only the U.S. stock market that “caught the flu.” It was an international pandemic of sharp stock market drops, depressed real estate values, currency fluctuations and collapsed business values.  Do you know the year of the previous market decline – before the Great Recession?  It was actually three years: 2000 through 2003.  

There have been five market declines in the past 30 years.  On balance, that number doesn’t seem like a lot and shouldn’t make that big of a difference in a retirement portfolio – right? Well, don’t jump to that conclusion quite so fast. Maybe those down years aren’t so tragic in the accumulation phase. You can keep your money in the market and wait for the inevitable rebound. However, imagine the impact if you were in the distribution phase. Removing money from a 401(k) or an individual retirement account when the market is down means that those assets will not be working for you when the market rebounds. Those dollars are gone. They were spent.  And now there is a double loss:  the loss of that asset when distributed and then the loss of that asset working for you in a rebounding market.

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The performance of assets in the years following retirement makes a significant difference in the long-term stability and longevity of assets during retirement.  Before retirement, assets may have endured market increases and decreases.  Upon retirement, however, all those prior years no longer matter. In effect, it is like starting fresh with the assumption that there are enough assets to make it through retirement.  But a down market in those early years can strain a portfolio because it is “digging out” of a market drop at the same time withdrawals are being made. The combined effect in those early years can have a long-term lasting impact.  

Let’s look at some history showing that timing is, as they say, everything.

Mid-1960s: Retirement Assets Eroded
Early 1970s: Retirement Assets Eroded
Early 1980s: Retirement Assets Grew
Early 1990s: Retirement Assets Grew
Early 2000s: Retirement Assets Eroded

Retire in the early 1980s and take distributions, no problem – retirement assets grew!  Retire in the early 2000s and take distributions, problem – retirement assets eroded.  The Wall Street Journal recently wrote about this issue earlier this year in the article “How Much Stock to Own in Retirement.” The article noted that market losses, particularly when they occur early in retirement, can erode an individual’s overall portfolio and affect long-term retirement funds.
 
What is the solution to this conundrum?  Put assets into certificates of deposit?  Nope. Inflation is a factor, and in the long term, there may be less money for retirement. Can advisors offer another way to provide security in retirement and protection for loved ones during working years?  Where can individuals acquire a “strategic bucket of money” that they can access in retirement to protect their overall portfolio during down market years?

It is well-established that diversification is a cornerstone in setting up a retirement portfolio. Traditionally, advisors look at different equity types, capitalization and types of fixed income. However, life insurance has a critical role in retirement planning – and that goes beyond the obvious. It’s a financial asset with unique attributes and tax treatment. It’s this unique set of characteristics that can make life insurance a cornerstone of overall planning to help meet and protect a retirement strategy. How?

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» As you know, life insurance can help the family meet its goals. During working years, life insurance offers a death benefit that can protect a family and meet retirement funding goals even if the individual is not around to contribute.

» Life insurance cash values receive potential income tax-free tax treatment.  Life insurance cash values grow tax free, and if properly accessed, they can be received tax free through withdrawals and loans. This offers a tax-free source of funds for retirement.

» Life insurance can offer cash value accumulation with downside protection.  Products such as indexed universal life insurance provide participation in part of a market’s upside, but protect downside risk. There is typically a floor through which the policy’s crediting rate cannot fall.  As a result, there is participation in some of the indices’ upside, but risks can be tempered.  It adds a stabilizing element. Other products, such as whole life, can offer a guaranteed return with no downside risk. Finally, some carriers’ general accounts are almost completely uncorrelated to the market (with investments that may include agriculture, timber and real estate) and thus offer terrific portfolio diversification.  

» And here is the best part. Cash value life insurance can do more than just provide a source of funding for retirement and protection for loved ones.  By strategically timing loans and withdrawals from a cash value life insurance policy, an individual can avoid selling into, and locking in, losses in traditional retirement assets.

How? A Case Study
Marcus is 65 and has accumulated $1 million for his retirement in personal savings spread between an IRA, a 401(k) account and a cash value life insurance policy.  His IRA and 401(k) were, and still are, invested in the stock market.  He needs $100,000 a year in retirement to maintain his lifestyle.  He anticipates taking $30,000 annually between Social Security and his company’s pension, and $70,000 annually from his personal savings.

As his advisor, you counsel him that if the stock market is unstable in his early retirement, he may not have sufficient funds. Taking funds out of his IRA and 401(k) year over year will lock in his losses during down market years. You also suggest that to be conservative on his assessment of the market, he should look back to the 1970s and 1980s, when there was a mix of gains and losses. Since 1950, every 20-year period in the market has shown at least four years with losses in the S&P 500. Looking at what might happen between when your client retires at age 65 and when your client reaches age 85 if there are five years of losses, especially early in retirement, is conservative and crucial.  

When assessing the assets to draw down in retirement, you advise your client against drawing on the life insurance policy’s cash surrender values year in and year out, along with the IRA and the 401(k). Instead, you advise him to access these policy values only in down market years to avoid selling into market losses.
Here are the astonishing results using a $1 million balance, taking a $70,000 withdrawal per year and mirroring the S&P 500 from 1973 to 1993. (The 1973-1993 time period was selected because it represented a time frame with early losses to demonstrate the effect of these losses on a retirement portfolio.)  
By minimizing market losses with a combined approach using his cash value life insurance and his IRA and 401(k), Marcus is able to smooth the uncertain waters of market returns.

Without Life Insurance to Smooth Uncertain Waters
If Marcus does not have a cash value life insurance policy and takes $70,000 per year for 20 years from his IRA and 401(k), here is the result (chart 1).

With Life Insurance to Smooth Uncertain Waters
If Marcus has a cash value life insurance policy and does not take a distribution from his IRA and 401(k) in down market years – taking a distribution from his cash value life insurance policy instead – here is the result (chart 2).

The difference? $4,004,003 versus $382,643 at age 85. Taking out $350,000 (or 20 percent of distributions) from the life insurance policy in the five down market years creates a difference of $3,621,360. Yes, you read that correctly.  Five years can make that big of a difference.

Advise your clients to diversify – but include a cash value life insurance policy in that diversification model. This will allow your clients to avoid selling into a down market and can thus produce truly dramatic results!

 

Gonzalo Garcia, CLU, Partner AgencyONE. Gonzalo is responsible for business development at AgencyONE. He can be contacted at [email protected] [email protected].

Liz Michel, JD, has built a reputation creating successful marketing programs for life insurance transactions. She has held senior positions with large, national brokerages including Crump and National Financial Partners. Liz is also a member of AALU. You may contact her at [email protected].


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