A new client came in recently who wanted to boost his retirement savings. The trick was he was 70 years old. He had realized there was a chance he could outlive the money he’d saved, and that he might not have anything left to leave behind for heirs. He was due to start taking required minimum distributions (RMD) from his IRA soon, and he was no longer eligible to contribute to it or other tax-exempt accounts used in retirement planning. Luckily, we were able to create a plan for him to boost his savings and create funds to leave behind for heirs by using universal life (UL) insurance.
When we meet with clients like this, we like to go over the pros and cons of using UL insurance as a tool in late retirement planning. While it isn’t right for everyone, it can be pretty helpful for those who have reached the point where they can’t use traditional retirement products. When used correctly, it can create a pool of income that’s there when you need it and available for heirs when you don’t.
Issues with Traditional Late Retirement Wealth Creation
Those who are trying to create wealth late into retirement, especially after the age of 70, are going to run into a few problems. First and foremost, traditional retirement accounts, like IRAs, can’t be contributed to by those older than age 70½, and 401(k)s can only be used if you’re working.
If you’re not earning traditional wages from employment or business income, contributing to a Roth IRA is out as well. Most types of savings plans designed for retirement require that you are either working, younger than age 70½, or both.
This can make building wealth and earning additional streams of income in late retirement difficult. Even if you are able to contribute to a traditional retirement account, you’ll have to start taking money out when you’re 70½ due to RMDs. While you can use non-retirement accounts, some of those have restrictions and surrender periods you may not appreciate. This is why UL insurance is often leveraged as a means of creating wealth in late retirement.
Wealth Creation with Universal Life Insurance
UL insurance is useful for more than just leaving death benefits to your heirs. It can also be used as a means of building wealth late in life while bypassing the normal restrictions of standard retirement accounts. There are no RMDs, you don’t have to earn income to contribute, and provided you get the right policy, you can accumulate a lot more wealth for you and your family than you would with a savings account.
The wealth building comes in the form of cash value you can use. With UL, you’ll have a standard premium due, but you can pay in more than that. Any amount you pay in above the premium is credited to the cash value of the policy. Then, that cash value is credited with interest earnings. In a standard fixed-rate policy, it will earn a conservative rate, often around 2%. However, there is a way to gain greater returns than that, which is usually done with an indexed universal life (IUL) policy.
IUL allows for higher returns because the policy increases based on the changes in a given index, like the S&P 500 or Nasdaq. The cash value will be credited based on how the index changes, but it’s not directly invested in that index.
This means that life insurance can be used as a market-risk-free means of gaining retirement income, while at the same time, allowing you to take advantage of gains in the market. If the index goes down, no interest will be credited to the cash value, but the policyholder won’t see a loss. IUL policies can be a great way to boost the value of cash value because, generally, indexes see better returns than a standard-rate policy.
After a while, this cash value could represent a significant pool of income. It grows on a tax-deferred basis, and death benefits are paid out tax free as well. This cash value can be drawn upon in the form of a loan, which is made at an interest rate much lower than a financial institution would likely offer.
The death benefit acts as the collateral for this loan. So if you withdraw funds from the cash value during your lifetime, you don’t have to pay them back. Instead, that withdrawal will be taken out of the eventual death benefit, with the remainder going to your heirs.
In late retirement, having these funds available can help to supplement your income. Unlike standard retirement products, you don’t have to take payments unless you need them. If the cash value accumulates enough, it can even be used to pay future premium payments, so you won’t have to make any out-of-pocket payments. While this can be a good way to create wealth, there are some drawbacks to using life insurance as a late retirement planning product.
The Risks of Universal Life in Late Retirement Planning
While universal life can be a good option for some, it’s not ideal for everyone. One of the first areas of concern in using universal life insurance for retirement planning is how it will impact your heir’s benefits. As using the cash value depletes the death benefit, if you use too much of it, there’s a chance that your heirs won’t have much left behind when you pass away.
The next issue is that it could take a while for cash value to grow enough to create a significant amount of income. Purchasing a UL policy is best done as early as possible because it could take a decade or more for the cash value to create a viable pool of supplemental income.
Finally, for individuals who are in poor health, premiums could be quite high, meaning that most disposable income would go to paying the premium, with little left over for dedicating to the cash value. These programs can be set up to allow tax-free loans or structured as a Modified Endowment contract, which will provide a better yield and return on investment but for all distributions other than the death benefit will be taxable. In this case, it’s best to talk to a qualified life insurance advisor, like one of Howard Kaye’s experts, as a means of finding the best possible policy for your situation. Call us today at 800-DIE-RICH to get started.