Many of the people who reach out to us are looking to use cash value life insurance to create retirement income.
They’ve heard about this possibility, read a book or two that talked about it, and in some cases even talked to a “certified” advisor. But they’re still scratching their heads a bit as to how it all works and even more frequently they’re convinced they’ve not really seen the best representation of the strategy.
In the last few years particularly, this strategy has gained significant momentum and it’s not all that surprising–with the sagging long term rates of fixed income investment vehicles (treasury bonds, corporate bonds, and CD’s) and with the volatility of the stock market since 2008 offering no real warm and fuzzy feelings.
It seems a great number of people came to the realization in the last market collapse of 2008 that perhaps they shouldn’t go “all-in”. That is to say they’re thinking twice about having their retirement savings tied up in the market without a safety net..
I Was Blind But Now I See
Now, we’ve been advocating this strategy for much longer than just since 2008. As a matter of fact I first presented this idea to a client of mine back in 2000, and I wasn’t the first by any stretch of the imagination. No great surprise that my first attempts to discuss the idea fell on deaf ears.
So it’s great to see that more people have been able to scrape off the insurance cataracts that blinded them to the potential of using cash value life insurance to create retirement income.
What I’m going to do in this post is take a snapshot of an illustration that we recently looked at. This proposal is really interesting in that it shows actual data from a life insurance illustration, the projected values and if we back tested the policy values, how it would have actually performed over the last few decades.
First, I should say that this is only one particular case. The individual in this illustration is a 37 year old male with great health, thus garnering a preferred plus rating on the policy.
We’re assuming that the policy is funded with $30,000 in year one (due to a 1035 exchange) and then roughly $22,000 each year and is done so every year until he reaches age 65. I’m not going to spend a lot of time here digging deep into the numbers and detailing every little thing, if you want to see all that feel free to contact us and we’ll be happy to share it with you.
However, I want to discuss one very important aspect of the policy we evaluated. I should start by telling you that this an indexed universal life policy that has a 2.0% minimum crediting rate and 12% ceiling (or cap if you prefer). And this particular contract is tied to the S&P 500 index.
What does all that mean?
Well it means that the credited interest in the policy is tied to the return of the S&P 500 for the given contract year with a cap of 12%. It also means that in any year where the market return is negative or flat, the worst you can be credited is 2%.
I know you want me to get on with it and I will…just wanted to make sure I covered the basics first.
Okay, so in the illustration, you are allowed to project a rate that the policy might earn throughout a person’s life. We typically don’t illustrate anything higher than 6%.
Wait a minute!
I just told you that you could do as well as 12%…right?
Yes, that’s true, however, we always believe it’s better to plan on an average much lower when we’re trying to target the use of cash value life insurance to generate retirement income.
Because the only variable in the retirement savings game that’s under your control is the amount of money you’re willing to commit during the funding period. You don’t know exactly what the rate of return will be over 20 or 30 years…do you? We sure don’t.
So, the best we can do is try to conservatively project what MIGHT happen based on historical averages. If your contract performs better, you’ll be happy…as I’m going to show you in just a moment.
Show Me the Goods
Okay, finally going to show you something.
This a snapshot of the “back-tested” illustration. It assumes that this hypothetical guy bought this exact policy back in 1972 when he was 38 years old. Using our 6% illustrated rate, the software told us that his maximum withdrawal from age 66-100 would be $93,336 per year.
If we look at the actual results below we’ll see some amazing things that I’ll point out below:
Click on the Image to Enlarge
1. Notice that in 2000 when our client is 66 he begins his withdrawal of $93,336 as planned, but instead of the $1,458,000 of cash value he was projected to have, he actually had $2,347,913 at the beginning of the year. Which is nice if you can get it…right?
2. Notice the S&P returned -10.14 his first year taking income and -13.04 the second year. Even though he started withdrawing income at the worst possible time (remember the market in 2000-2001) his net rate of return was still positive both of those years with 1.87% and 1.64% respectively.
This is exciting!
Well, it is for nerds like us anyway.
It means that even in “bad boy” years (negative years in the market) as some of our colleagues refer to them, an indexed universal life insurance policy can still deliver a positive net return after accounting for loan interest and internal expenses.
Now, mind you not all policies would be able to do this, but this one will and we know of at least one other one that could pull it off.
3. The $93,336 he receives in loan proceeds from his policy every year from age 66-100 is done without any tax implication. Not much more to say about that.
4. Fast forward to the end of 2011 (the last full year we have complete data) our client has withdrawn a total of $1,120,032 in tax free income. He still has a death benefit of $3.4 million and can safely continue his withdrawals for retirement income. And keep in mind his total cost basis in the policy from age 38-65 was $643,471.
Yeah I know, that’s the sort of reaction a lot of people have the first time we show them something like this. Most of the time, they’ve already purchased cash value life insurance from another source that sang the praises of the products, the retirement income benefits etc.
Unfortunately, the agent then proceeded to design the policy in such a way that maximized his/her commission rather than maximizing the retirement income benefit to the client. That’s why so many people are convinced this doesn’t work, and that’s sad.
If you’re interested in learning more about how to use cash value life insurance to create retirement income, contact us to find out if it might work for you.