A lot of retirees are finding out early into their retirement that they’re facing the “gap.” This was the case with one couple that came into our office for some retirement restructuring. The issue they were facing was that one of them had to retire earlier than expected due to a health problem. As a result, they needed to find a way to squeeze another 10 years out of their retirement funds. Those 10 years are what we call the “gap years.”

This couple wasn’t alone. In fact, about 65% of U.S. retirees don’t have enough money to cover their entire retirement. But there is hope. Using insurance as a strategy to cover the retirement gap can be a helpful tool for those who want to know how to make retirement savings last.

Why Insurance Over Investments?

If you need to cover gap years, you might immediately look to investments because you think they are the best ways to build funds quickly. The issue with investments is that only the riskiest ones offer extremely large returns. But on top of those large returns, they’re also extremely volatile, meaning that you could actually lose more than you earn. As a result, just focusing on investments is not the way to go when you need to cover the gap.

Instead, you may want to look at insurance. With an insurance-based product, like an annuity or universal life policy, you can get a guaranteed interest rate that will allow your premium to earn money. For someone who is facing an imminent gap in their funds, an annuity is often a good way to go.

Annuity Solutions When the Gap Is Imminent

Single premium immediate annuities, or SPIAs, are commonly known as longevity insurance because they’re designed to protect you from outliving your savings. What happens is you make a premium payment up front, and then the company will start making monthly payments to you either for a set period of time or for the rest of your life. This can allow you to stretch that income out for a longer period of time — often much longer than if you’d simply taken withdrawals from the funds alone.

The SPIA also eliminates market risk because these insurance policies pay out regardless of what happens in the investment market. SPIAs are guaranteed through the companies that issue them and are protected by state-backed insurance funds. In a situation where someone is past the age of 70, a SPIA can be used to supplement Social Security payments or other sources of income, meaning that the retiree can avoid the gap.     

SPIAs have an additional facet, which can be leveraged to minimize yearly income taxes. SPIAs are often purchased with after-tax funds, so only a portion of the future payments that come out of them are taxable. This is known as the exclusion ratio. The exclusion ratio is the percentage of your payment that is tax exempt. For example, say you had an annuity that paid $10,000 per year with a 70% exclusion ratio. That exclusion ratio would mean that $7,000 of that yearly payment would be exempt from taxes. The excluded amount is not considered part of your yearly income, so it offers the added benefit of potentially lowering your tax bracket.

SPIAs can also be structured to protect loved ones, so if having money left behind for heirs is important, then you’ll want to discuss refund options. Alternatively, if you need both protection and income you may want to consider indexed universal life insurance.

How Indexed Universal Life Protects You Against Potential Gaps

Indexed universal life insurance isn’t ideal for an immediate need for gap coverage, but it can be useful if the gap is 10 or more years away. This type of universal life insurance has a cash value portion that you can leverage to supplement your income later on. The interest crediting is usually based on a market index that has earnings potential without risk of market loss. You’ll pay a premium every month and a portion of that premium will be added to the cash value. In the early years of the policy, a higher amount of the premium will be used to fund the cash value.

As you grow older and mortality charges increase, a larger portion of your premium will be used to insure you while less will go to the cash value. This is why using universal life to fund a retirement gap is something that you should only do if you think a gap is possible sometime in the distant future. The longer you pay into the policy, the longer that cash value will have to grow.

You can then remove the cash value by taking out a low-interest or interest-free loan against your policy. It’s not necessary to pay the loan back because if you pass away and still owe money on the loan, it will be taken out of the death benefit. If you never use the cash value, then eventually your heirs will get your death benefit. This is why this tactic is a better option for those who might face a gap but aren’t certain they will.

Of course, there are more options than simple SPIAs or indexed universal life policies, but these are the most common insurance policies used to fund the retirement gap. Some individuals choose to get annuities with a life insurance rider to protect heirs, while others might focus on longevity annuities that don’t pay out until the insured is 80+ years old.

There are dozens of insurance opportunities to fund your retirement gap and Howard Kaye works with more than 50 highly rated insurance companies to find the right solutions for all of our clients’ diverse needs. If you want to find a way to fund your retirement gap, contact us at 800-DIE-RICH for more information.

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