Some say that whole life insurance only makes sense for the ultra-wealthy. Believe it or not, one of the top-ranked websites for personal finance makes this claim about whole life insurance, “…such policies usually only make sense for individuals with a net worth of at least $11.4 million” (estate tax exemption threshold).
Uhhh…not sure how they reached this conclusion and of course reading horrible misinformation about whole life insurance is not uncommon.
We’re using that quote as an example of what the internet views as being authoritative information about whole life insurance. By the way, the article where it was pulled from promises to discuss the same topic I’m writing about here.
However, I’m pretty sure if you read their article next to this one, you’d swear we’re not even talking about the same thing.
Why Would Anyone Want to Use Whole Life Insurance for Retirement?
If you’re asking this question, you’re one of those curious people that we welcome with open arms to this website. A major reason that we’ve kept after producing content here for over eight years (you read that right) is that we both tend to have contrary viewpoints.
It’s not that we’re disagreeable for the sake of it. Not at all in fact.
But we have a unique perspective to offer you having been trained by large mutual companies that specialize in selling participating whole life insurance. We’ve both been licensed to sell securities (stocks, bonds, mutual funds, etc.), had some experience in the wholesale distribution side of the financial services industry as well and one of us owned an RIA at one point as well.
Having done all of those things and experienced the sausage-making process of financial planning and retirement planning, we reached the semi-educated conclusion that whole life insurance can, in fact, be used for more than paying estate taxes. It also serves a purpose for people who aren’t “ultra-wealthy”. In fact, most of the people we help are far from ultra-wealthy. Most earn above-average incomes and are definitely way above average with their level of financial discipline.
With that experience, we’ve narrowed down three distinct ways that whole life insurance can be used in retirement. These are not the only uses for whole life in retirement.
But these are the three that can have a direct impact on retirement income which we have found to be the most popular discussions from our clients and potential clients.
We’re going to look at the following three ways that you can use whole life insurance for retirement:
- As an alternative to loading up qualified plans
- Income source rotation
- To Build an Income Stream That Lasts Forever (with guarantees)
But first, let’s explore how the whole life policy would even have the cash to provide for you in retirement.
How Would Whole Life Insurance Deliver For You in Retirement?
When you own a whole life insurance policy, the premiums you pay accumulate cash value. Not all of the premiums you pay go directly to the cash value, but a portion of the premium does.
The cash value of your whole life insurance policy can be taken out at any time and for any reason. You don't have to die in order to use the cash value in his or her life insurance policy. But in this context, we’re looking at how it can benefit you in retirement.
You can take cash values out of a life insurance policy in two different ways.
1. Withdraw cash from the policy
2. Take a loan against the policy
When you take a withdrawal from a whole life insurance policy it means that you are removing the cash from the policy. The option to take withdrawals is available for every whole life insurance policy I’ve ever seen. That being said, taking withdrawals is something that you need to explore first and make sure that you understand the implications of it as it is irreversible.
Why would that matter? Well, if you withdraw cash from your policy, typically you are surrendering paid-up additions. That means those paid-up additions will no longer earn dividends. It’s not a bad thing, just need to be sure you know that and understand how it will impact your policy going forward.
A loan does not mean you removed cash from the policy. Instead, the insurance company lends you money. You then pledge cash in your life insurance policy as collateral for the loan.
The method you choose to access cash in a policy depends on specific circumstances. These circumstances include personal matters about the policyholder as well as the specific life insurance contract.
It seems like everywhere you turn in personal finance websites, publications and books, you’ll find advice that recommends you take full advantage of your 401k, IRA or whatever flavor of qualified plan you have the ability to fund. The rules of each are slightly different but the tax treatment for each is the same.
Defer current income, pay no income tax on the deferred amount, your money grows without tax and when you are around 60 you can take the money from your qualified plan without a penalty. Obviously, you’d pay taxes at that point. How much you pay will depend upon your other sources of income.
I’m not going to exaggerate and suggest that you’ll be paying a 62% effective tax rate when you retire. Though we have certainly seen some outrageous claims about tax rates.
We take a contrary position here. Not that we like paying taxes nor do we suggest that your patriotism is tied to paying taxes.
But today, we’re suggesting there could be another consideration than just the tax argument, though we will touch on that one below as well.
Lemme share a short story with you…
A couple of years back, I was at a meeting with other financial professionals. Before the start of the main event, I was walking around meeting people that I hadn’t met before.
During that time, I had the privilege of meeting a guy who claimed he’d been listening to our podcast for years and reading our blog. I’m always flattered and forever stunned. Weird to think that people you’ve never met spend the time to listen to what you have to say. It’ humbling.
But I digress…
As we were talking, we were lamenting how tough it can be at times to get people to pay attention to the message we’re trying to convey. Long story short, he began telling me about his father.
A guy who’d been around the life insurance industry for decades and is now semi-retired as I understood it. What the younger son was conveying to me is the conviction he had in funding life insurance as opposed to loading up his own qualified plan (though he had a 401k available).
[Quick sidebar here from me…I’m not suggesting that all qualified plans are bad and that no one should ever use them. People have different reasons and different circumstances. The details do matter.]
His Dad created a six-figure retirement income exclusively using the cash value from various policies that he had. I’m not sure of the companies, products, etc. It doesn’t really matter.
The point of the story that the young man shared with me was that he had recently looked at his father’s tax return and verified that “on paper” he had no reportable income from investments, pensions, etc. His only source of reportable income for income tax purposes was social security.
He paid no taxes at all because the rest of his income is derived from life insurance policies that he funded over his working years. Income from a life insurance policy (particularly if it’s all in the form of policy loans) does not apply toward provisional income calculations either, so none of his social security is taxed either.
Is this the right solution for everyone? Probably not but it is interesting to look at those cases out on the edge to see what’s possible.
You may have heard someone mention or read somewhere else online that you should plan to withdraw no more than 4% of your assets in retirement? This is what’s commonly referred to as the 4% rule.
There’s a lot of common financial wisdom floating around out there and one of the favorites relates to the 4% rule. People will suggest that if you just follow the 4% rule everything will work out fine.
After all, average market index returns have far exceeded that and despite the up and down, if you keep withdrawals to no more than 4% you’ll be fine.
The idea is that it will ensure you against running out of money over time as you take the money that you need to live from your total pool of liquidity in retirement. It was conceived by William Bengen back in 1994 and further analyzed by three professors at Trinity University in what has become known as the “Trinity Study”.
This has led a lot of financial professionals to recommend a plan where individuals liquidate no more than 4% of total assets in any given year to cover retirement expenses. And there’s a lot of hypothetical data to support it, just google it, you’ll not run out of reading any time soon.
Maybe it will work out for some people but our suspicion is that it’s way oversimplified and really doesn’t account for at least two separate risks (though there are others):
1. That there could be a significant drawdown in your investment account(s) during the early years of your retirement income phase of life.
2. That you will ignore all external information and blindly follow a rule of thumb come hell or high water.
Why not be a bit more selective in how you choose to take income and perhaps consider using whole life insurance as a core component of your retirement income plan?
Here’s an idea, just like most people aren’t going to put all their eggs in the whole life insurance basket, maybe consider not putting all your eggs in the “I’m gonna withdraw 4% of my investment account value” basket.
What if you treated your whole life insurance policy as another asset pool that you could use as a source of income?
And instead of taking 4% every year from your investment accounts no matter how poorly the market performs, you alternate what source of money is used to withdraw the money you need to live.
What I’m sharing is also an oversimplification but the idea is valid. The particulars are dependent on each person’s unique situation.
Consider this…what if you alternated. You save and invest in your retirement plans, investment accounts, stock purchase plan and you also fund a whole life policy.
When you retire, you take your income from investment accounts following the year when they are up and you take your income from the whole life policy the year following a market drawdown. Obviously, you could mix and match here, I’m just floating an idea.
Remember, life insurance companies tend to invest their reserves conservatively. Part of that is just the nature of the life insurance business and the other part is the regulations that govern how they’re allowed to do invest their reserves.
Yes, dividend rates can and have decreased in the last decade. But I was just looking at a big mutual company’s complete dividend history yesterday and current dividend rates are not an anomaly. They’ve been low before and the policies thrived in spite of it.
Life insurance is an inherently profitable business and your policy dividends benefit from that in addition to the insurance company’s ability to create decent investment returns in their general account over time. Whole life insurance is truly non-correlated and creates a more efficient portfolio mix when viewed in the context of being another asset, rather than a “have to” expense.
I wish I had a more up-to-date graphic to share but this is still relevant. Look at how whole life insurance adds to overall portfolio efficiency:
Using your whole life insurance policy to purchase an income annuity is an old idea that no one really talks about anymore. Well, no one really talks much about income annuities at all, they’re not sexy and the returns are not that great in our current environment of super-low interest rates.
That’s a shame really. Income annuities are among a small handful of ways that a person can absolutely guarantee a stream of income that will last until you die.
I ran a quote assuming that a 65-year-old male uses a 1035 exchange to move 300k from his whole life insurance policy to a single premium immediate annuity. Based on a single-life payout with an installment refund (if he hasn't received all of his principal when he dies, his beneficiary will continue to receive the annuity payments until all the money has come back).
Here's the outcome:
Now, many people will look at that and think that they can do better than that. They don't wanna give up control of their money in exchange for a guaranteed income stream.
Others will claim that the monthly annuity income is too low, they need more income. We get it, but maybe you could shift your perspective a bit and realize that these numbers are realistic. If you need more income, you need to grow the total size of your income-generating asset pool.
Whole life insurance works in retirement and for more reasons than the three I've listed and described here. If you'd like to see how it can work for you, reach out and let's talk about it.