Many people do not view life insurance as an asset class, an essential and vital part of their retirement income plan. They see life insurance primarily as a way to protect families from the early loss of a breadwinner during the working years. However, life insurance has the potential to be so much more if properly utilized in a comprehensive retirement income plan.
How Life Insurance is Vital for Retirement
Life insurance plays an important role in any financial plan. It helps loved ones recover from financial risks and unexpected costs, increasing their chances of reaching long-term goals and achieving dreams. Thinking about financial protection and retirement can seem overwhelming, but as your life changes so does your financial situation.
Unfortunately, many people do not fully understand nor appreciate the value and benefits that life insurance can represent as part of a retirement plan. Having the correct life insurance product and the appropriate amount of life insurance coverage in retirement will accomplish multiple jobs. It can help protect your income, provide tax-free cash flow, help manage taxes, provide peace of mind to families, and even improve the total returns in a portfolio.
Diversifying Your Portfolio
With interest rates close to historical lows, bonds and CDs are not an attractive investment for many retirees today. However, most people still need some safe investments and assets in their retirement income portfolio.
Tom Hegna, CLU, ChFC, CASL, a professional retirement planning speaker, suggests positioning life insurance as a substitute for bonds in a retirement income portfolio. “Right now bonds have very little upside. They are only paying in the 1 to 3 percent range. Yet the risk of holding bonds is very high. If interest rates rise, the downside risk to bonds could be 20-30 percent or more.” Hegna recommends, “retirees should consider a indexed universal life policy as a bond substitute for some or all of their bond portfolios. The life insurance policy can provide bond-like returns of 4 to 6 percent without the interest rate risk of a bond.”
Indexed Universal Life Insurance
As you may already know, Indexed Universal Life (IUL) insurance is a type of permanent life insurance. Compared to a standard whole life insurance policy, where there is a given (and usually quite low) rate of return on the cash value, the indexed universal life insurance policy allows you to “earn” a market return on your cash value based on an index, thereby mimicking the performance of the overall stock market.
An IUL policy may be used to accumulate substantial retirement savings as well as provide for beneficiaries should the owner die prematurely. Because the money paid toward this product has already been taxed, withdrawals, and or loans, can be made tax-free. This tool benefits policyholders who wish to generate savings at a lower tax rate than they may encounter in the future
IUL policies mimic a specific stock index, such as the S&P 500, and provide returns based on market performance. Once the cash value has built up to a substantial level, the client can begin taking tax-free withdrawals/loans to supplement their retirement income.
With an IUL, only the premiums that are not used towards life insurance coverage are used to build tax-deferred cash value. And since an IUL is used for life insurance, as well as a cash accumulation tool, the owner’s age and overall health can have a huge impact on premium costs, which would ultimately hurt the accumulation. However, the added death benefit of the IUL, pays tax-free dollars to the designated beneficiaries should the owner die prematurely.
Although IULs can generate a considerable amount of cash value, this product must be well-funded by the owner in order for it to preform as intended. Allowing the policy to lapse can actually leave the policyholder with a large tax bill, so the owner should be advised that this is a long-term planning strategy with potentially significant penalties if the policy is surrendered or lapses.