3 insurance policies that could help pay for retirement
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.
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Variable annuities let you invest in accounts similar to mutual funds, and the money grows tax-deferred until it's withdrawn.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.
"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.