Whole-Life Policies: Insurance or Retirement Savings?

    As the tax code continues to play a larger role in retirement planning and preparation, insurance products are very commonly being substituted for other more traditional retirement products.

    One commonly sold product is the whole-life insurance policy, which provides for a benefit after death, as well as exposure to the stock market and an opportunity to extract cash out of the policy in retirement years. Even more frequently, whole-life policies are redeemed for annuities, allowing for a pension income and death benefit all in one.

    Whole-Life Policies' Bad Reputation

    Whole-life policies have earned a bad reputation from such popular commentators as Dave Ramsey and others for being expensive. However, while whole-life insurance products can be costly, their price comes as a result of their safety and security. Few investments offer guaranteed retirement payouts, nor the tax advantages of whole-life insurance, and even fewer at the same price.

    More so than ever, whole-life policies are fulfilling a role left voided by Social Security, a welfare program most future retirees have accepted will either be out of money or will pay only a pittance at the time they choose to retire.

    In addition, with whole-life insurance companies earning an AAA credit rating just like the US government, but without the more than ten trillion dollars in national debt, insurance companies are starting to look like a very safe bet.

    Turning Whole-Life Insurance into a Safe Pension

    Turning a whole-life insurance policy into a tax-free pension is done quite easily. Life insurance associates can help you structure a pension much like the example below is organized.

    Let's assume that first you are a 40 year old male making enough income to save some $1,200 per month for retirement. You are also a non-smoker, and you want to invest until you reach 65 before beginning to withdraw your profits for retirement income at 70 years old. Keep in mind that smokers will pay several times more for whole-life insurance, and they may be wiser to opt for other vehicles that aren't dependent on their own health or well-being.

    Starting from year one, this $14,400 annual premium will buy a policy worth just over $380,000 in death benefits at the time of purchase, which can be projected to grow reasonably to $450,000 in death benefits by the age of 65. Thus far, all we have done is assumed a purchase of a whole-life insurance policy with a cash value and death benefit. Nothing else has been considered.

    Extracting the cash value from a whole-life policy is completed best with a loan against the whole-life policy. Normal extractions, or those completed by withdrawal, reduce the death benefit and are not tax-free. A loan against a whole-life insurance policy is most often called a “universal life” policy, where the company loans cash in monthly disbursements against the cash value of the policy. This loan, however, does create some risk, which will be explained later in the article.

    This transaction, or the loan, would provide for income of greater than $32,000 per year, tax-free from the age of 70 to 85 years old. And even at 85, the owner of this policy would still retain a total death benefit of $145,000.

    Pros and Cons

    There are many pros and cons to the strategy above. First, are the benefits, which is $480,000 in what is essentially annuity income derived from a loan against the whole-life policy. Also, even after a large amount of extracted capital, the whole-life insurance policy still retains some $145,000 in death benefits at 85 years old. Should the policyholder die, this value would be passed on to relatives without any estate or transfer taxes.

    There are some potential risks to the strategy, as well. Should you live for many years past 85 years old, then you risk exhausting the cash value and having a gaping hole to be filled by other income or investments. Likewise, all income from the loans ceases at 85, which means other income will have to be found to sustain life in retirement.

    Use Only for Generational Wealth

    While whole-life policies do provide security, they can be quite the gamble as well. For most, a classic annuity will provide the income needed to sustain a reasonable standard of living through retirement. However, annuities are not free of estate taxes, so policyholders with an annuity death benefit rider will not be able to pass down excess savings without triggering taxes and penalties.

    There is a very commonly understood idea in finance and statistics that risk should be embraced when there is ample time or resources to recover. Retirement, contrary to some future retiree's plans, is not a time to embrace risk-taking, unless resources exist to provide some security. An annuity provides a very safe, secure return without the tax benefits, while a whole-life policy generates income for a short period until the loan is repaid. Where an annuity pays until death, the whole-life policy pays only until 85.

    To prove this point, we can use the same statistics, including the total amount invested, the length of the term and retirement age. The same investment and growth in an annuity would provide for retirement income of $3,255 per month, subject to taxes, until death. This annuity is $39,060 per year in taxable income until death. However, unlike the whole-life policy, if one were to die with this annuity at 85, no benefits would be passed on. In the case of the whole-life policy, $145,000 would be passed on to survivors.

    Keep in mind, also, the fact that without a rider, an annuity does not compensate for an early death. Thus, someone who invests $450,000 into an annuity could die the next day and lose every single dime. The whole-life insurance policyholder would receive some $380,000 in benefits.

    All in all, annuities provide safety and security without tax advantages or the opportunity to pass down generational wealth. Whole-life policies, on the other hand, provide life insurance protection with a short burst of tax-free income. However, outliving a whole-life policy can be financially disastrous if there are no other existing retirement plans.
    Tim Ord
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