Use Life Insurance to Create Tax-Free Retirement Income?

Life Insurance for Tax Free Retirement Income

Many of the people who we speak with on a regular basis are looking to use cash value life insurance to create retirement income. Just so we're all on the same page, cash value life insurance includes–whole life insurance, universal life insurance, and indexed universal life insurance.

People have heard about the 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've concluded that they have not really seen the best representation of the strategy.

And that would by a very wise and often times accurate conclusion.

In the last few years particularly, the 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 here 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 38 year old male with great health thus garnering a preferred rating on the policy.

We’re assuming that the policy is funded with $25,000 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 is an indexed universal life policy that has a 1.0% minimum crediting rate and 13% ceiling (or cap if you prefer). And this particular contract is tied to the movement of the S&P 500 index.

Wait a second…

You're probably saying to yourself, “I thought you guys were all about stopping market losses?  Why are telling me about something that's tied to the S&P500?”

And that's a fair question.

What does all that mean?

Well it means that the credited interest in the policy is tied to the upward movement of the S&P 500 for the given contract year with a cap of 13%.  It also means that in any year where the market return is negative or flat, the worst you can be credited is 1%.

Make sense?

I know you want me to get on with it and I will…just wanted to make sure I covered the basics first.  Again, I want to reiterate, your worst case scenario in any given year of this contract is that you'll earn 1%.

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 13%…right?

Yes, that’s true, however, we always believe it’s better to plan for a lower average 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 1974 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 $95,571 per year.

If we look at the actual results below we’ll see some amazing things that I’ll point out to you:


 Click on the picture to enlarge

1.  Notice that in 2001 when our client is 66 he begins his withdrawal of $95,571 as planned but instead of the $1,493,081 of cash value he was projected to have, he actually had $2,326,260 at the beginning of the year.  Which is nice if you can get it…right?

2.  Notice the S&P returned -13.04% his first year (2001) taking income and -23.37% the second year (2002).  So, he started withdrawing income at the worst possible time (remember the market in 2000-2002) yet his net rate of return was still positive both of those years with .78% and .56% respectively.

You have to admit, that's powerful.

It means that even in “bad boy” years (negative years in the market) , an indexed universal life insurance policy can still deliver a positive net return after accounting for loan interest and internal expenses.

Not all policies would be able to do this but we know of at least one other that could pull it off.

3.  The $95,571 he receives in loan proceeds from his policy every year from age 66-100 is done without any tax implication. It's not reported on his tax return, not included in calculations for income tax and has no capital gains tax implication. Not much more to say about that.

4.  Fast forward to the end of 2013 (the last full year we have complete data) our client has withdrawn a total of $1,242,423 in tax free income.  He still has a death benefit of over $4.3 million and can safely continue his withdrawals for retirement income.  Also, something worth mentioning…the total amount of money he put in the policy from age 38-65 was $675,000.

You're Speechless Right?

Yeah I know, that’s the sort of reaction a lot of people have the first time we show them something like this.  And many times, 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 designed their policy in such a way that maximized his/her (the agent's) 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 you can use cash value life insurance to create retirement income…