A retirement planning strategy that was popular in the 1980s but fell out of favor is being revived: using life insurance to create personal, defined retirement income, much like a defined benefit plan.
Wealth2k, Inc. recently launched such a strategy called DB-by-INS, which the Hingham, Massachusetts-based company says refers to the defined benefit nature of the retirement income provided and the vehicle used to provide it: life insurance. The DB-by-INS strategy–which uses either variable universal or indexed universal life insurance policies as its funding vehicle–is particularly useful for the affluent market, says David Macchia, CEO of Wealth2k, because the caps on contributions to defined contribution plans like 401(k)s limit the affluent’s ability to create a sufficient percentage of retirement income in comparison to their pre-retirement income. With the migration to DC plans over the past two decades, retirement security today looks a lot different than it did 20 years ago, Macchia says. As defined benefit plans have fallen by the wayside and the longevity of Social Security is questionable, “it has dawned on people that retirement security has been diminished because, for most people, there is no predictable level of retirement income.”
How It Works
The DB-by-INS strategy uses an administrative system that allows clients to set a long-term strategy for making their retirement income more secure. The DB-by-INS strategy “wraps around the life insurance funding vehicle and transforms it into a DB,” Macchia explains. A policy owner will first start with buying a life insurance policy, “but you don’t want to buy a life insurance policy with the intention of trying to build as much insurance in it as possible,” he says. “You want to do the opposite–you’re trying to buy close to the minimum insurance possible for a given dollar amount because you don’t want to burden the concept with too much cost; insurance can be costly.” The policy owner then decides the age at which they wish to retire, their target retirement income, and an assumed interest rate growth.
Macchia offers this example of how the DB-by-INS strategy works. A policy owner wishes to retire at age 65 with $50,000 in annual income and an annual growth rate projection of 7%. “Let’s say [that] based on those three factors, annual [premium] cost will be $12,000 from that retirement income. What happens is that one year later, the performance of the policy was probably something less than or greater than 7%; let’s say it was 6%,” he says. “The insurance company will send an annual report to the policy owner and say, ‘We didn’t hit the 7% assumed rate of return, so in order to keep on track to produce the $50,000 retirement income at 65, you’re going to have to make a small adjustment to your cost, and the premium for the next year will go up to $12,100.” Jump forward one year, and the interest rate hits 8.5%. The insurance “company would then send a letter saying the premium would decrease to $11,800.” By making adjustments to the policy each year, “you create the ability to keep that policy on track to deliver the retirement income,” Macchia says. “What I just described was the mechanics of the defined benefit pension plan. What this DB-by-INS does is recreates that, in an economic sense, in the form of an individual life insurance-funded defined benefit pension plan.”
The Loan Benefit
Perhaps the best benefit for policyholders, Macchia says, is policy loans against the cash value. “The policy loans are income-tax free; so if I realize my $50,000 retirement benefit at age 65, that may be the equivalent, depending on tax brackets at that time, of having a taxable income of $90,000.” There are two ways to withdraw cash from a policy, he explains. “One is a simple withdrawal, which is taxable to the extent of any gain in the policy. The other is a loan against the cash value. A loan is income-tax free because, in a tax sense, it is considered as an advance against the policy’s death benefit, which is also a tax-free distribution.”
Protective Life of Birmingham, Alabama, is now offering a DB-by-INS strategy dubbed Defined Objectives, and several other companies are in the early stages of bringing the concept out.