We all remember the classic story of Ebenezer Scrooge in A Christmas Carol. The final powerful lesson for Ebenezer was the tremendous impact his actions had on himself and the lives of many, impacts that were in the here and now, and well into the future. Much like Ebenezer learned from the ghosts of his past, so can your business-owner clients.

Regardless of income bracket, whether it’s middle income or high net worth, there is a common hope for our clients’ future. Like Ebenezer, the actions our clients take today have impacts in the present and well into the future. So, what does the future look like? How can you help your clients maintain their current lifestyle, while simultaneously planning for their financial future?

We must learn from past financial successes and failures, identify the present financial situation and predict future income levels. Combine that basic formula with your client’s retirement lifestyle goals, and you have the basic foundation to design a solid strategy that will help them obtain a realistic and obtainable retirement. Let’s take a look at how this formula can be applied to a client’s situation.

Below we will examine three client scenarios based on income levels of $150,000, $300,000 and $700,000 and assume that our client is in their mid-40s. These scenarios include opportunities for pretax and after-tax strategies as well as qualified and nonqualified plans. Since each client is different, we must keep in mind that any variation in the facts and circumstances of our client could change the recommendations.

Our review must start with a look into the future:

How much capital will it take to produce an income of 100% of pre-retirement income, beginning at age 65, that would last at least to age 90?

The numbers are large, and the math does not change based on the client’s income. Our first step is to figure out their capital requirement, or in other words, “What is their number?”   

In order to find their number, there are some factors that must first be determined. You must define a target income level for your client with the understanding that this will likely change over time. For this example, let’s make a few assumptions.

  • 100% pre-retirement income into retirement
  • 6% return on assets
  • 3% inflation adjusted income to age 90.

The three income levels are $150,000, $300,000 and $700,000. For our client scenarios, the following was calculated with these assumptions using retirement software: 

Annual income to replace

Capital Required

$150,000

$4,000,000

$300,000

$9,000,000

$700,000

$21,000,000

Based on the above output of the retirement software, the capital required includes the present value of Social Security retirement benefits. The calculations assume that the client takes full retirement at age 67. In many cases, waiting to take Social Security until age 70 may make sense, but not in all. You will want to make sure that the client fully understands all of their options before they decide when to access their benefits. Those numbers can be worked many different ways, depending upon facts and circumstances that can change at any time. The Social Security Administration has a number of valuable tools to help guide you and your client through the decision-making process. There are also independent consultants that can provide a complete analysis of a client’s Social Security options.

Once we learn what their future number must be, our analysis can return to the present:

How is the client going to reach their number?

This is a big question that most clients cannot answer independently. There are many options and strategies available to help the client reach their retirement goals. Creating a strong and robust accumulation and income plan should be their first step in their planning. Let’s begin with a conversation on qualified plans. Qualified plans are a great pretax strategy available to our clients.

Qualified Plan Creation and Design Considerations:

  • Age
  • Compensation
  • Cash flow available for contribution (budget)

One strategy involves the use of an ERISA Defined Benefit Qualified Plan. 

Assuming the client has eligible compensation of at least $215,000 in 2017, they can fund for the maximum defined benefit payable for life of $215,000 per year. This benefit can commence at a retirement age of 62 at the earliest, or 65 at the latest, and with a minimum of 5 years participation in the plan. In order for the plan to pay this benefit amount, the plan must accumulate a lump sum value at retirement of about $2.5 million. 

The maximum income that can be considered in determining the benefit your client can fund for is $270,000 in 2017.  

How much income can you replace using a maximum defined benefit limit to fund a life annuity of $215,000 per year?

Annual income

Amount of income replaced

$150,000

100%

$300,000

70%

$700,000

30%

Defined benefit plans typically allow the largest pretax contribution of any qualified plan type for clients age 40 or older. The higher contributions allowed in a defined benefit plan can go a long way in helping to achieve a client’s goals, and are extremely underutilized as a retirement planning technique.

A more commonly known qualified plan is the 401(k) plan and may be a good strategy for younger business owners. With a 401(k) there is much left to the unknown. Funding levels and asset allocation both play a major role in what that accumulation number could become. If we use the client’s number from our scenario above as the target, and adjust for inflation, the 401(k) plan will get us part of the way there. If your client believes that a 401(k) plan alone will meet their retirement needs, they will be disappointed.

By combining a defined benefit plan with a defined contribution plan, such as a 401(k) plan, the client could take advantage of some unique planning opportunities.

The tax deduction and tax-deferred growth options within qualified plans make them the most efficient place to accumulate wealth. However, it is all taxed as ordinary income at distribution, either during the client’s lifetime or at time of death. With the right strategy it is possible to distribute qualified plan assets at a lower tax rate, which can result in a tax deductible, tax deferred savings and tax-advantaged distribution. 

However, in our $700,000 income example, we have to make up for almost 70% of additional assets outside the statutory restrictions of a qualified plan in order to produce the desired income your client will need.

How do you make up the difference? You will need to pull out all the stops and consider as many double-duty dollars as possible. One solution that is often overlooked is permanent life insurance. Modern life insurance products combine life insurance protection with additional protection in the form of optional accelerated benefit riders that allow access to the death benefit while living in the event of a qualifying illness.1 Permanent life insurance also offers the ability to accumulate tax-deferred cash values that can be accessed, if sufficiently funded, using policy loans and withdrawals2 to supplemental retirement income on a tax advantaged basis.

As financial professionals, we shouldn’t overlook the insurance protection need. To protect a client with a $300,000 income in the event of a premature death would require around $6 million in life insurance protection. It is very possible to purchase protection on a pre-tax basis through a qualified plan and on an after-tax basis as part of a nonqualified strategy.

The benefit of purchasing life insurance with after-tax dollars is the tax-free treatment of loans and withdrawals. Additional benefits of using tax-free3 loans and withdrawals to potentially supplement retirement income include:

  • Helps protect against income tax rate increases. If the life insurance is structured properly, cash value distributions during lifetime can be received income-tax free. If tax rates increase, your client can tap their insurance cash value for income without creating additional tax burden.
  • Saves on Medicare Part B premiums by reducing modified adjusted gross income if you can get $1 below defined income tiers. Medicare and You is a free and great resource detailing the subject.
  • May save on Social Security taxes.
  • May save the 3.8% Medicare surtax.

To this end, I highly recommend creating a comprehensive approach to ensure that you are carefully addressing all planning possibilities and providing a complete approach on behalf of your client and their retirement objectives. It would be wonderful if, like Ebenezer, we all had a ghost of “Yet to Come,” who would appear and provide us with that crucial glimpse into our future based upon our decisions in the here and now. Perhaps that’s what retirement planning is at its core: a professional peek into your client’s financial future at what could be achieved through careful planning and proper actions taken today.

1. Payment of Accelerated Benefits will reduce the Cash Value and Death Benefit otherwise payable under the policy. Receipt of Accelerated Benefits may be a taxable event, may affect your eligibility for public assistance programs, and may reduce or eliminate other policy and rider benefits. Please consult your personal tax advisor to determine the tax status of any benefits paid under this rider and with social service agencies concerning how receipt of such a payment will affect you. Riders are supplemental benefits that can be added to a life insurance policy and are not suitable unless you also have a need for life insurance. Riders are optional, may require additional premium and may not be available in all states or on all products. This is not a solicitation of any specific insurance policy.

2. The use of cash value life insurance to provide a resource for retirement assumes that there is first a need for the death benefit protection. The ability of a life insurance contract to accumulate sufficient cash value to help meet accumulation goals will be dependent upon the amount of extra premium paid into the policy, and the performance of the policy, and is not guaranteed. Policy loans and withdrawals reduce the policy’s cash value and death benefit and may result in a taxable event. Surrender charges may reduce the policy’s cash value in early years.

3. Withdrawals up to the basis paid into the contract and loans thereafter will not create an immediate taxable event, but substantial tax ramifications could result upon contract lapse or surrender.