Permanent life insurance can be a great vehicle for implementing a supplemental retirement strategy, but the details involved with using life insurance that way may be hazy even for financial professionals who have life agent licenses.
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Here’s an introduction to life insurance “life insurance as a retirement strategy,” or LIRS, aimed at financial professionals who are just starting to learn about this topic.
1. What products can serve as good vehicles for LIRS?
The term LIRS captures the more expansive view of permanent life insurance rather than the commonly held notion that life insurance is only useful as a death benefit.
There are many types of life insurance products and LIRS can only be fulfilled with “permanent” life insurance – products that build cash values over time, such as whole life (WL), universal life (UL), variable life (VUL) and indexed universal life insurance (IUL), and generally, will continue death benefit coverage so long as premiums are paid.
Contrast that to “term” life insurance, a policy type that has no cash value or investment component and simply provides a benefit at death. However, term insurance also typically expires after a certain term of years.
LIRS are most stable with WL insurance because of the strength of premium and cash value guarantees, the overall lifetime cost of ownership, and the general predictability and lack of any significant variability that can occur with UL, IUL and VUL. Whole life insurance is intended to maximize both cash values and death benefits, and WL insurance issued by mutual life insurance carriers may also pay dividends that can be used to increase the death benefit and cash values.
2. How do LIRS arrangements work?
LIRS takes advantage of the favorable tax treatment afforded to permanent life insurance by law. The three most important features are (1) income tax-free death benefits; (2) the growth of the cash values inside a permanent policy is deferred from taxation while the funds remain in the policy; and (3) policy cash values can be accessed on a tax-favored basis by withdrawals or through policy loans or a combination of the two.
It is through these last two features that make LIRS stand out as an effective supplement to retirement savings and income. Withdrawals from a life insurance policy are generally treated on a First-In First-Out Basis meaning that withdrawals to the extent of cost basis are considered a tax-free return of cost basis. During the insured’s life, loans taken against a whole life policy will generally not trigger a taxable event, even though the policy may have a large gain in excess of premiums paid. Cash values can be accessed on a demand basis through a policy loan at any time and for any reason, without the application and approval process that is required for consumer or business loans. Once a policy loan has been taken, any annual dividend paid can be used to help pay back a policy loan. If the loan is not repaid, the loan balance will merely reduce the death benefit and cash values.
3. Who are LIRS ideal for, and who should stay away?
LIRS is ideal for anyone seeking to maximize cash values for retirement beyond employer sponsored retirement plans and IRAs. They must also have a need and/or a desire for life insurance coverage because after all, these are life insurance policies first and foremost, and the premiums paid are partly directed towards the death benefit protection of the insurance.
Practically every adult has some desire or need for life insurance, but those who have limited financial means and cannot even take advantage of matching programs from an employer sponsored retirement plan should probably seek to maximize that benefit first.
4. What LIRS features are most important, and what should you watch out for?
The most important features in LIRS is product choice and its design, and the financial strength and stability of the insurance carrier. The values contained in a life insurance policy may be a major source of accumulated cash values and security for your family. Quite distinct from most other types of financial instruments, such as savings accounts and short-term investments, a permanent life insurance policy is expected to accumulate cash values and eventually pay a death benefit many years into the future. Therefore, the long-term financial viability of the life insurance company you are considering should be a major consideration in your decision. The carrier’s financial ratings and strength, and commitment to treat all policy holders fairly is a hallmark of a great company. To ensure the stability of the insurance product and to enforce the promises and guarantees that have been made in the insurance contract are the cornerstones of great companies.
Also, the product choice and design must have the ability to build up cash values over the long term, and building them quickly relative to the premiums paid can be a great benefit, as well. Whole life insurance is ideal for LIRS due to the guaranteed buildup of cash values regardless of market and economic conditions and guaranteed level premiums. Whole life insurance issued by a mutual insurance company may pay dividends, which can increase cash value buildup.
And finally, one of the other unique and largely misunderstood benefits of whole life is the way it enhances the value of other assets during retirement. The presence of a guaranteed death benefit gives the owner the ability to use assets in ways that would not be possible if the insurance did not exist. The death benefit provides the “permission slip” that may enable you to spend down principal and interest from other sources to maximize retirement income, knowing that insurance proceeds will replace the principal for the family upon death.
5. Can you handle this yourself, or do you need to work with a LIRS specialist?
If you are reading this, and you are already an experienced life insurance agent, you may be well on your way to becoming an LIRS pro.
If you are not yet licensed to sell life insurance, or you have a license but sell life insurance only occasionally, you may need to work with a life insurance professional who has extensive experience with LIRS arrangements.
Due to the many types of permanent life insurance products that exist, with different ways to design each product, as well as the many life insurance carriers that sell these products, all with varying financial stability and strength, a life insurance professional would be needed to help a consumer wade through all of the choices and make an educated decision. Further, a professional can help with the decision, implementation, and monitoring of any policy where a loan or withdrawal is being considered. This is especially true if any systematic withdrawal or borrowing of policy cash values is part of the client’s plan. Having a professional who understands the interplay of these transactions can be critical to ensuring the success of anything the client implements.
6. How have LIRS performed over time?
Generally, LIRS has performed very well over time but performance is dependent upon product and insurance carrier choice. Mutual insurance carriers, like The Guardian Life Insurance Company of America, are among the top 2% of over 630 insurance carriers rated by the four major rating agencies (i.e., A.M. Best, Fitch, Moody’s Investor Services, and Standard & Poor’s). While dividends are not guaranteed, a strong track record cannot be overlooked.
7. What are the alternatives to LIRS?
LIRS is meant to be a supplement to employer sponsored retirement plans, IRAs, and other long-term vehicles. They are not meant as replacements for these plans. If a consumer is already saving in a tax-advantaged retirement plan, there are few comparable alternatives to LIRS because other financial instruments such as bank savings accounts, CDs, mutual funds, equity brokerage accounts, bonds, etc., don’t have a death benefit, and may not have the tax-advantaged growth that life insurance cash value buildup has, or there may not be tax-advantaged methods to access those other types of savings vehicles such as policy loans or basis withdrawals of insurance cash values.
Even tax-advantaged retirement plans and IRAs have restrictions imposed on them that do not apply to LIRS, such as income limits, contribution limits, penalties for early withdrawals, the inability to access funds before a certain date or event, etc.
Many life insurance products also offer many types of useful riders not available in other financial vehicles such as a waiver of premium in the event of a qualifying disability or a rider to help pay for long term care (LTC). The waiver of premium rider allows an insured who is totally disabled to stop paying premiums. Yet, the policy continues building up cash values because the insurance company continues to pay the premiums while the insured remains disabled.
— Read 5 Living Benefits Available With IUL Products on ThinkAdvisor.