Today I am presenting a guest post from a fellow personal finance blogger who proposes an interesting strategy for using whole life insurance as a way to generate retirement income. I will have some comments about this strategy at the end of the post.
Evan from My Journey to Millions is a New York attorney who works as a support staff in a large financial planning firm, has a small Trust and Estates Practice and is the sole owner and author of My Journey to Millions. His blog discusses estate planning, insurance planning and his personal struggle from a broke law school graduate to his dream of netting millions. Check out his blog for more information, or better yet just subscribe to his feed.
Using Whole Life Insurance to Create a Pension Income Stream
Rather then discuss fees, expenses, mortality charges, IRR, etc. I am going to build a real example using a real illustration program from a AAA rated insurance company. I will then compare that option to various returns.
Let’s choose our variables:
- 50 Year old Male;
- I will use the 2nd highest health rating (not a beacon of health but not standard);
- Like a “real” pension we are going to pay into the system until retirement in this case 65 (Chose a product that stops premiums at 65 automatically);
- We are going to pay into the system $1,000/month; and
- Going to take an income stream from 70 to 85.
All these variables will change the whole model, I just made these up because if I had to venture a guess Mr. GoTo’s demographic is likely to be around these variables. Why did I choose 70 as a starting age? Well the cash value is growing tax deferred so why not let it grow for as long as possible?
In Year 2011 $12,000 will buy just about $319,000 in death benefit which will grow (non-guaranteed) to over $420,000 of death benefit when the client is 65.
- Then from age 70 to to 85 you will be provided $27,200/year tax free (through loans and switching at basis)
- At age 85 there will still be a death benefit of a little bit over $130,000
Is this method perfect? No. There may be tax issues if the policy crashes, but neither is the standard 401(k) as we all learned, both young and old. Imagine if you were the one trying to retire in 2002, or more recently 2007. My firm saw an increase in the amount being deposited with the insurance company (above their premium) because it was their only account that increased in value.
Comparing Whole Life Insurance as a Pension Income vs. Investing
This strategy is not going to work if you are getting 12% return, or even 8%…but if you are 63 and are in 100% equities then I am sure Mr. Tough Money Love will have something to say to you. (Editors Note: Yes I will!) So, lets use a 4% net return (so we can either assume your holding muni’s or netting 4% on your portfolio).
|Year||Age||Balance||Interest||Withdrawals||End of Year Balance|
This is all without a death benefit to go along with it. If I use 6% net (8%+ gross) then I can safely say that the investments will “win.” This strategy, on the other hand is relying on a AAA rated Company that has been around longer than some states.
Disclaimer: While I am licensed to sell life insurance, I have never sold a single policy nor do I own any whole life insurance since The Wife and I have different priorities right now. I hope to purchase a policy by the end of the year.
Does anyone have any experience with this strategy?
Mr. GoTo’s comments:
Most personal finance writers not connected with the insurance industry will tell you that term insurance is preferred over whole life insurance as a financial tool to protect dependents in the event of your premature death. I agree with that. Yet I like this post from Evan because it discusses alternative uses of cash value life insurance.
Keeping in mind that most of the money you take out of a cash value insurance policy is a return of your own premiums, it is a way to achieve tax deferred growth, or even “tax free income” if you are willing to periodically borrow from your cash value and not repay it. You have to be careful, however, of the potential tax consequences of dying with policy loans outstanding.
As Evan acknowledges, the net investment returns achievable from cash value life insurance can be inferior to the alternatives. Nevertheless, there are wealthy investors who use cash value life insurance for tax and estate planning when they run out of better options. If you plan on being this wealthy and need death benefit protection, it can’t hurt to at least consider this “life insurance as pension” strategy now.