Believing that a retirement fund will last throughout retirement may lead to a false sense of security; educating clients on how life insurance can be used to help supplement retirement income can go a long way toward keeping clients on track.
The number one fear Americans have about retirement is running out of money before they die.1 (By the way, number two is not being able to maintain one’s current lifestyle; number three is healthcare expenses.1 We’ll get to healthcare later in this article.) With all the responsibilities holding business owners’ constant attention, it’s understandable why they may put off preparing for the future. But the future is closer than many think. In fact, a little over half of small business owners are age 50 and over.2
With your financial guidance and the flexibility that permanent, cash value life insurance can provide, you can help to dispel three common retirement myths many of your business owner clients may hold:
- (My spouse and) I will retire on what I sell the business for.
- I already save in a qualified retirement plan and I’ll get Social Security benefits—I’m all set.
- If I become chronically or terminally ill in retirement, Medicare will have me covered.
Life insurance as part of an overall retirement income strategy can help. And policy premiums don’t necessarily always come from the business owner’s personal pocket; many times, they come from the business. Life insurance can also provide tax advantages.
1. (My Spouse and) I Will Retire on What I Sell the Business For.
Many business owners don’t save, or save very little, for retirement because they intend to live off whatever they sell their businesses for. Maybe it will be enough, maybe not. Here are three ways life insurance can help:
- Supplemental, Tax-Free Retirement Income.
- Executive Bonus Arrangement.
- Buy/Sell Arrangement.
The main purpose of life insurance is to provide a death benefit to dependents. Permanent, cash value life insurance also has the potential to provide your clients with supplemental, typically tax-free income when they retire. This is done when, in retirement, they take loans from the policy’s cash value. Of course, it’s important to note that loans are charged interest and taking loans from a policy can reduce, or even eliminate, the policy’s death benefit. And if the policy terminates prior to death of the insured, the loan becomes immediately taxable to the extent of gain in the policy.
Executive Bonus Arrangement
An Executive Bonus Arrangement can provide an attractive tax advantage. Using this strategy, the business pays the life insurance premiums. The policy is owned by the business owner, who is also the insured. When the owner retires, he or she can take typically tax-free loans from the policy to supplement income. Loans are income tax-free as long as the policy remains in force.
Outstanding loans and withdrawals will reduce policy cash values and the death benefit and may have tax consequences.
Many business owners haven’t articulated a strategy for ensuring the highest possible valuation of the business.3 Ideally, there should be a detailed succession and/or transition plan that includes instructions for the method to be used when valuating the business. This isn’t just for retirement income; it’s also important in the event of the business owner’s death.
With a buy/sell arrangement, the business owns a permanent, cash value life insurance policy on the life of the business owner; the business is also the beneficiary.
- When the business owner retires, and if sufficient cash value has accumulated, the cash value can be used to purchase the retiring owner’s share of the business.
- If the business owner dies prior to retirement, the typically income tax-free death benefit is ready cash that can be used to purchase the owner’s share of the business. If there’s a surviving spouse, he or she can use that money as part of a retirement income strategy.
A buy/sell arrangement funded with life insurance can also be a prudent strategy when a share of the business will go to the business owner’s estate or when the intent is for equitable distribution to children who will not participate in the business.
2. I Already Save in a Qualified Retirement Plan and I’ll Get Social Security—I’m All Set.
Maybe. But consider that 100% of all money in qualified plans is taxable when received as income. And when the business owner dies, that money may be subject to federal and state estate taxes. What’s more, Social Security income may be taxable too. In other words, your clients may not be taking taxes into consideration when estimating how much retirement income they’ll need.
They may be able to supplement their retirement incomes with typically tax-free loans from a policy. This can add tax diversification to their retirement income sources.
Also make your clients aware that when they delay receiving income from Social Security, generally up to age 70, the amount of the Social Security income benefit will increase annually. Loans from the cash value of a life insurance policy can provide them with supplemental income as Social Security is delayed.
Here’s a hypothetical example. Elise is 40 years old and owns an architectural firm. Assuming she has earned a consistent $100,000 each year of her career, Elise’s monthly Social Security benefit would be:
Hypothetical calculations in 2017 dollars, based on the Social Security Online Quick Calculator, https://www.ssa.gov/OACT/quickcalc/index.html.
3. If I Become Chronically or Terminally Ill in Retirement, Medicare Will Have Me Covered.
There are many unexpected expenses your clients may face in retirement. The cash value in a permanent life insurance policy may help, including keeping pace with inflation, dealing with emergencies, helping adult children, caring for aging parents, and adjusting to changes in the tax code.
Consider the expenses that your clients could be faced with should they become chronically or terminally ill. Every other person who is age 65 will face a chronic illness or disability later in life.4 Medicare will provide some coverage, but it has limits, both in dollar amount and duration.
If your business owner client becomes chronically or terminally ill, some policies offer an optional rider that accelerates the death benefit while he or she is still living. This money can help supplement other financial resources and be used in any way they choose. Present your business owner clients with permanent policies that offer such a rider, and show them how this flexibility may help. Be sure to explain that accelerating the death benefit will reduce, or possibly eliminate, the death benefit.
Dispel the Myths
There are 28 million small business owners in the United States5 and many believe these retirement myths. They need your help. Life insurance can provide a tax-efficient way to protect loved ones and to implement several other strategies. When it comes to having enough money to last throughout their retirements, life insurance can be especially valuable. From supplemental retirement income to tax diversification to flexibility should they become chronically or terminally ill, life insurance can play a critical role.
Discover other ways that life insurance from Prudential can help your clients address concerns about outliving their retirement savings, plus four additional retirement derailers.
For more information on other ways that life insurance from Prudential can help you address the unexpected during retirement, visit www.prudential.com/personal/lifeinsurance.
1 Index Annuity Leadership Council 2016 Retirement Study, https://indexedannuitiesinsights.com/retirement-data.
3 http://www.cnbc.com/2015/06/23/most-millionaire-business-owners-have-no-succession-plan.html, 2015 U.S. Trust Insights on Wealth and Worth® Survey, Accessed January 17, 2017.
4 Favreault & Dey, Long-Term Services and Supports for Older Americans: Risks and Financing, ASPE Issue Brief, U.S. Department of Health & Human Services, Office of the Assistant Secretary for Planning and Evaluation, July 2015.
5 https://www.sba.gov/managing-business/running-business/energy-efficiency/sustainable-business-practices/small-business-trends, U.S. Small Business Administration, Small Business Trends, Accessed January 17, 2017.
Cash value life insurance policies are issued by Pruco Life Insurance Company (except in NY and/or NJ), and Pruco Life Insurance Company of New Jersey (in NY and/or NJ). All are Prudential Financial companies located in Newark, NJ. Life insurance policies contain exclusions, limitations, reductions in benefits, and terms for keeping them in force. A financial professional can provide you with costs and complete details.
Prudential Financial and its financial professionals do not give legal or tax advice. You should contact your own advisor.