An Innovative Way to Address Today’s Retirement Planning Challenges

Retirement planning is an imperfect science, but today, with numerous macroeconomic factors at play, including volatile equity markets, inflation at a 40-year high and interest rates on the rise, accurately predicting how much clients need to save for retirement today is even more difficult. In light of this planning environment, now may be the opportune time to revisit the importance of asset diversification as part of a retirement planning strategy and offer clients a solution to protect their retirement savings, providing a backstop against these largely uncontrollable risks.

Retirement Risks
During working years (the “accumulation period”) when most people are diligently saving for retirement, they are also often working with a team of financial professionals to determine how much they should save and which investment vehicles to consider to help achieve their goals. In determining this amount, clients often consider how much they need, when they will need it, what they think their money can earn and for how long it will need to last. The savings amount is based on the current and projected future worth of the client’s IRAs, 401(k)s, Roth IRAs, and perhaps even life insurance.

Throughout the accumulation period, in most cases, individuals are less concerned about the sequence of returns, so long as they average the assumed rate of return over an extended period of time. If they assume their accounts will grow at 8% overall, does it matter if in year 1 they earn 4% and in year 2 they earn 12%? While true that the risk of the timing of return rates is minimized over an extended accumulation period, the sequence of returns becomes more damaging during the distribution period (i.e., retirement). If accounts underperform during the distribution period, it is difficult, if not impossible, to make up for the loss.

In addition to market uncertainty and the timing of investment returns, other factors may impact clients’ long-term retirement savings plans:
- Longevity – what is the probability of living beyond life expectancy?
- Taxes – do clients believe taxes will increase in the future? The Congressional Budget Office estimates the deficit between revenue and spending will reach more than 6% of GDP by 2032. Considering taxes are primary source of revenue for the US government, and as such, it may be reasonable to assume income taxes may rise.
- Inflation – with the US CPI index accelerated to 9.1% in June 2022, clients today are acutely feeling the impact of high inflation. How might rising inflation eat away at purchasing power in retirement?
- Prolonged illness – medical or long term care needs may considerably strain a clients’ retirement funds and impact what is left for a surviving spouse and other heirs.

Factoring anyone of the above risks with the unpredictability of sequences of returns indicates that clients may withdraw more in retirement years than expected, potentially draining their retirement accounts more quickly than anticipated and frustrating long-term planning goals.

Retirement income “backstop”
A cash value life insurance policy can be a very useful backstop against these risks. Consider the many benefits cash value life insurance can provide:
- A death benefit that provides a self-completing benefit in the event of a premature death or replenish diminished retirement assets for surviving spouse.
- Tax deferred growth of cash value which can provide a source of discretionary, non-reportable, tax-free distributions (loans or withdrawal of basis), further helping to minimize tax risk.
- Inflation-protection through product selection. For example Indexed Universal Life or Variable Universal Life can help offset the risk of inflation as accounts are indexed to (or participate in) market performance.
- Riders for long term care can help protect the other investment accounts from unexpected costs due to illness risk.

Additionally, the sequence of returns risk can be mitigated through cash value life insurance, providing an extra source of tax-free supplemental income via potential policy cash value to tap into during a market downturn. Depending on product selection, the sequence of return risk may be further mitigated. For example, in an Indexed Universal life insurance policy, the indexed accounts can control sequence of return risk, as cash values are protected from market losses and the fixed accounts of all cash value products provide a stable yield to minimize the sequence of return risk.

The retirement income backstop plan helps to minimize the risks of death and illness with the policy death benefit and long-term care benefits. Tax risk is eliminated as policy values grow tax-deferred. Loans from the policy are free of taxation and not reportable as income (unlike 401(k)s or IRAs). The withdrawal rate risk is minimized by being able to vary the loan amounts (unlike IRAs where Required Minimum Distributions must be taken). The sequence of return risk is minimized in Indexed UL as the indexed account cash values are protected from market losses. In addition, the fixed account of all cash value products provides a stable yield to minimize the risk.

In today’s challenging economic times and with clients concerned about the stability of their own retirement, now is an excellent time to be discussing the benefits of permanent life insurance as a long-term investment. Through product selection and structure, there are many ways to design a flexible plan to help address clients’ concerns and offer a solution that will endure economic uncertainty and help clients achieve their long-term retirement and legacy goals.

Disclosure: Insurance policies and/or associated riders and features may not be available in all states. Some riders may have additional fees and expenses associated with them.

Loans and withdrawals will reduce the death benefit and the cash surrender value, and may cause the policy to lapse. Lapse or surrender of a policy with a loan may cause the recognition of taxable income. Withdrawals in excess of the cost basis (premiums paid) will be subject to tax and certain withdrawals within the first 15 years may be subject to recapture tax. Additionally, policies classified as modified endowment contracts may be subject to tax when a loan or withdrawal is made. A federal tax penalty of 10% may also apply if the loan or withdrawal is taken prior to age 59 1/2. For variable policies cash value available for loans and withdrawals may be more or less than originally invested. Withdrawals are available after the first policy year.

Life insurance death benefit proceeds are generally excludable from the beneficiary’s gross income for income tax purposes. There are few exceptions such as when a life insurance policy has been transferred for valuable consideration.

This material does not constitute tax, legal, investment or accounting advice and is not intended for use by a taxpayer for the purposes of avoiding any IRS penalty. Comments on taxation are based on tax law current as of the time we produced the material.

There is risk as the performance of the underlying index may result in low segment interest credits that would require increase in premium payments in order to the keep the policy in force.

Variable universal life insurance has annual fees and expenses associated with it in addition to life insurance related charges (which differ with the product chosen), including surrender charges and investment management fees. Variable universal life insurance products are long-term contracts and are sold by prospectus. They are subject to market risk due to the underlying sub-accounts, and are unsuitable as a short term savings vehicle. The primary purpose of variable universal life insurance is to provide lifetime protection against economic loss due to the death of the insured person. Cash values are not guaranteed if the client is invested in the investment accounts. There are risks associated with each investment option, and the policy may lose value.