Most people who are planning for retirement fund their 401Ks and
use financial vehicles like mutual funds, bonds and securities to
save money. But you may have overlooked life insurance in your
planning efforts.
Although there are some caveats, certain forms of
life insurance
can provide funds in your senior years.
"In most cases life insurance is probably not appropriate until
all of the tax qualified plans -- IRAs, 401Ks, etc. -- have been
maxed out and one doesn't have any more of those vehicles to invest
in," says Rob Drury, executive director of the Association of
Christian Financial Advisors, a non-profit coalition of over 3,000
financial advisers based in San Antonio.
But if you're looking for an extra boost, here are three
insurance options.
Annuities
While annuities can help supplement retirement, the best part is
that they grow tax deferred but are fully taxed at your tax bracket
when you take money out.
Variable annuities let you invest in accounts similar to mutual
funds, and the money grows tax-deferred until it's withdrawn. Most
companies offer an add-on guarantee for an extra fee, either a
guaranteed minimum income benefit (GMIB) or a guaranteed minimum
withdrawal benefit (GMWB).
"Inside the annuity you may have an interest-bearing account or
mutual funds that give you the opportunity for a higher rate of
return. There are also indexed annuities that limit any losses, but
also may limit future growth," says Sheldon Weiner, founding
partner at the financial planning firm Egan, Berger & Weiner
LLC., in Vienna, Va.
An annuity may cost 0.6 percent to 1 percent of your investment,
plus the standard annuity fee of 1.4 percent, which can be twice
the cost of a mutual fund.
GMWB allows you to withdraw up to a certain amount each year
from the initial investment for the rest of your life, no matter
how the investments perform. Even if the account is depleted, the
insurer pays the guaranteed amount. This makes it an attractive
insurance vehicle for retirement.
A 5 to 6 percent annual return is typical in a good market. Some
products increase payouts if your investments increase. You can
withdraw your account balance at any time, but many annuities
impose a surrender charge if you cash out within the first six to
seven years of the annuity. There's also typically a death benefit
feature to help your heirs pay future estate taxes.
The
SEC has tips for researching variable annuities
.
"What sells variable annuities today are the extra bells and
whistles such as a guaranteed growth rate on future income and
guaranteed withdrawal rates. This helps take away the downside but
does not limit the upside in a bull market," says Weiner.
The best time to buy a variable annuity is when the market is
high and you want protection against a fall. When you purchase a
variable annuity in a strong bull market they do well. If however,
they're purchased in a bear market, or they're owned during a
severe bear market, your investment performance will likely
stagnate. Insurers aren't able to manage these as effectively as
they manage mutual funds in a down market.
Annuities are hardly right for everyone. They limit liquidity,
have surrender charges if you want to abandon them, and can carry
expensive fees. "But they may be right for people who don't have
enough Social Security or pension income or those who cannot sleep
at night because of worries about the stock market," says
Weiner.
Permanent life insurance
Permanent life insurance accrues a cash value over the life of
the policy. Unlike
term life insurance
, which doesn't accrue cash value and simply pays a death benefit,
the cash component in permanent life builds up over time, and the
policy owner can take a loan against the cash value.
If you hold your permanent life insurance policy for decades,
giving the cash value time to build, you could have a very nice
nest egg at retirement. Even if you never use the cash value, you
have the life insurance if you pass away.
Permanent life aims to provide protection
and
growth. The cash that builds in these policies is not taxed until
it's withdrawn, and you can avoid those taxes by taking a loan
against the account, which reduces the death benefit. This is its
main advantage. Here's more on
cash value life insurance
.
"Critics will say, 'You'll pay interest and also you're removing
cash value and putting the policy at risk of lapsing.' There's some
truth to that," says Drury. You want to prevent a lapse. When a
policy lapses and you've borrowed money from it, the IRS looks at
that withdrawal as income, making it a taxable event.
Permanent life insurance as a retirement fund may make sense for
high earners who max out other tax-deferred savings. It also may
benefit older folks who have illiquid estates, like small business
owners who want to leave money to someone, yet the death benefit is
more than what they'd be able to save. Plus, anyone in a position
to retire early, in their 40s or 50s (before they can access their
qualified plans) may be a candidate for permanent life since there
are no age restrictions to funding life insurance.
This strategy is not for people within 10 to 15 years of
retirement.
In the last 15 to 20 years, "the interest on the loan is a
little bit higher than the earnings on the cash values. It used to
be a wash," says Drury. "You earned about as much as you were
paying -- you were basically accessing that money for free. It's
still pretty darn close."
Return of premium term life insurance
Return of premium (ROP) term life insurance policies are a
special variety of level term policies. If the customer hasn't
passed away during the term of the policy, he gets all his premium
money back. You do pay considerably more in premiums for this
option than you would for a regular term life policy.
For example, a 40-year-old male in a standard, non-nicotine
class who purchases $500,000 in coverage for 20 years could have a
term premium of $755 per year. An ROP policy would be $2,945.
That's a $2,200 difference per year.
But the policyholder would receive $58,900 at the end of the 20
years according to ING U.S. Insurance Solutions' figures.
"If you took the difference between $755 and $2,945 and you
wanted it to grow to that $58,000, you'd have to have a rate of
return of almost 4 percent on a pretax basis in order to have your
invested difference equal the same rate of return as the ROP," says
Al Lurty, senior vice president and head of business development
for ING U.S. Insurance Solutions.
That's a strong rate of guaranteed return. And there is no tax
on the money because it is a return of your premiums. "Try to find
a rate of return of 4 percent today -- good luck," says Lurty.
The key is to look at the difference in the premium of what you
would have paid on a regular term policy versus an ROP, and see if
you could invest the difference and get a better rate of
return.
If you buy a 20-year ROP term life policy at age 45, you'd
receive your chunk of money back at age 65 - just when you're ready
for it. If you pass away during the policy period, your
beneficiaries receive the death benefit.
This strategy isn't right for someone who'd rather invest the
difference between a term life policy and an ROP, or who thinks
they'd do better elsewhere.