How To Use Life Insurance In Your Retirement Planning

Investing in the market without taking losses — is it too good to be true? Not according to the University of Michigan’s head coach Jim Harbaugh. In August, University of Michigan helped Harbaugh become the top-paid college football coach in the nation, according to USA Today figures, by creating a deferred compensation package utilizing cash value life insurance called Indexed Universal Life Insurance (IUL).

Just like in Harbaugh’s case, IULs appeal to many executives and business owners because of the advantages they provide. IULs allow cash value within the policy to grow tax-free over time. IULs are funded with post-tax dollars which allow clients to withdraw money tax-free at any age, and provide financial security in the form of a death benefit for the family after the client passes.

One of the main advantages of IULs is that the cash value is protected from drops in the market. An IUL is a cash value policy that has both a death benefit and a savings portion. In an IUL the investments are not placed directly in the market where they would be subject to a loss. Rather, they are put into a strategy that mirrors an index such as the S&P 500, which allows the participant to realize all or most of the gains in the market. These gains are then locked in to protect against potential losses.

In addition, when compared to an IRA or a 401(k), IULs provide more flexibility. Unlike IRAs and 401(k)s, there is no limit on how much money can be added annually, as long as the added cash does not create a Modified Endowment Contract (MEC), which is taxable. An MEC is where the funding has exceeded the IRS limitations known as the “7-pay test,” which limits the amount of excess cash that can be put into a policy in any seven-year period before it loses its tax advantages. IULs allow for a high cash value at the beginning of the policy. There are no restrictions on when the money can be taken out, unlike an IRA. Also, the money inside an IUL can be taken out at any age by the client tax-free and without extra fees.

An IUL is beneficial to those who are looking to invest their extra money tax deferred after they have fully utilized their other retirement accounts, such as a 401(k). IULs are also beneficial to those who clients who do not qualify for a Roth IRA. IULs provide an opportunity for individuals to allocate premiums to flexible and accessible tax-deferred accounts. For younger clients, savings can be rolled over from a previous retirement plan. IULs can also help people who started retirement planning later, due to the fact that an IUL can be over-funded, unlike a 401(k) or IRA, which have strict contribution limits.

Along with tax-free wealth building, IULs provide a source of financial security to the family in the event of death or disability. In an event of the death of the policyholder, the death benefit is received tax-free by the beneficiary of the policy in a lump sum. Some policies can be constructed to include living benefits in the event of disability or chronic illness. In this way, IULs provide a way in which individuals can grow and protect their income, as well as provide extra funds for retirement.

In the case of coach Harbaugh, an IUL was used to save millions in tax-free retirement. This was possible due to the growth of the cash value inside of the policy that increased his retirement funds, which are accessible tax-free at the age of 70. Upon being hired at Michigan, Harbaugh entered a split-dollar loan agreement, in which the premium, cash value and death benefit is split between two parties. This split-dollar agreement was funded by cash value life insurance policy or IUL.

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An Understandable Life Insurance Analogy

Clients need to make corrections to account for changes in interest rates.

There’s such a lack of understanding about how life insurance actually works (not conceptually) that sometimes it’s difficult to have a meaningful conversation because you have to back up so far to establish a point of commonality. Even when people don’t fully understand it, they still have a fundamental, base level understanding, but even that’s generally wrong. It isn’t easy to destroy a foundation that someone believes is sound.

Advisors should have a working knowledge of life insurance so they can help lead their clients through the process. When I’m working with someone who has a policy that’s dramatically underperforming and I explain to him how the policy works, that the drastically reduced interest rate market will cause his policy to collapse when the cash value is exhausted, he’ll nod dutifully as though he understands. Until I see a visceral reaction, I don’t know if he really gets it. He’ll look at me and say, “I get that, but my death benefit is still there so do I really care?” See what I mean? Until his face turns red and he starts yelling about the crooked industry, I have to keep pushing and prodding because telling someone that even though he dutifully paid his premium out of pocket each and every year, as illustrated on the original sales ledger, doesn’t translate into actually getting a death benefit. By the way, most permanent insurance works this way, even most of the whole life policies I see.

I’ve tried to come up with an analogy that almost anyone can understand as to why most life insurance acts the way it does. Following is my best stab at it.

Retirement Planning Analogy

Let’s look at your client’s retirement planning. Hypothetically, as the plan is visualized, when your client is working, he’s earning more than he’s spending. Earnings over and above living expenses are put into a side fund that earns a return and grows over time. Then, in the future, when your client is retired and his living expenses exceed his earnings, expenses are subsidized by the side fund so your client doesn’t starve to death.

With life insurance, your client’s premiums today are more than the actual cost to insure him. The excess is put into a side fund that earns a return over time. Then, in the future, when the cost to insure your client is greater than the premium, expenses are subsidized by the side fund so the policy doesn’t starve to death.

So far so good? Let’s go a little further. Your client’s retirement funding is based on some assumptions and expectations. To know how much your client should put away into his retirement plan side fund every year, he has to make decisions regarding his expenses in retirement and what his investment earnings will be over the coming decades. Sometimes this works out and sometimes it doesn’t. Sometimes his expenses will be greater than he thought. Sometimes he won’t earn as much on his investments as he expected. When this happens, your client intellectually knows that the formulas he originally worked by aren’t going to pan out and he has to adjust. Sometimes the adjustment is putting more in the side fund and sometimes it’s reducing expectations regarding what your client can live on later.

With life insurance, the funding is also based on some assumptions and expectations. To know how much to pay in premiums for a certain number of years, your client has to make decisions. These decisions include how much insurance he wants in force and for how long, as well as his expected earnings over the coming decades. Sometimes this works out as expected and sometimes it doesn’t. If it doesn’t earn as much cash value as expected, your client needs to understand that the formulas he originally worked by aren’t going to pan out and he has to adjust. Sometimes the adjustment is putting more in the side fund and sometimes it’s reducing expectations regarding the death benefit that can be supported later and for how long.

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How Much Life Insurance Should You Have?

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Most people are aware of the function of life insurance: it is a contract you enter into with a financial institution, most often an insurance company, to pay out a predetermined cash amount to a designated beneficiary, or beneficiaries, at the time of your demise. The purpose of legitimate life insurance policies is to give you the assurance that those you most care about will be provided for financially after you can no longer look after them yourself. But it’s a sad fact that many people nowadays procrastinate initiating a life insurance contract, or never bother to do it at all. These people are not really selfish or lazy — they just don’t ‘get it’ when it comes to the vital importance of good coverage.

In 2016 a national financial insuring association discovered that nearly a third of households in the United States lacked any significant life insurance protection. Their research also uncovered the fact that nearly half of those polled felt the need to upgrade their insurance coverage. To insurance companies and their agents, this is a crying shame.

It is an axiom that the majority of people in the United States have some kind of recognition that life insurance should be an important part of their financial portfolio — and a big reason they don’t follow through on what they know to be true is because of lack of full trust in the insurance industry and the rates they apply to individual policy owners. Most insurers and their agents invoke the basic rules of financial planning when selling to a customer — that is, you should purchase enough life insurance to bring about five to ten times your yearly savings to your beneficiary. This approach, however, is not viewed with a great deal of confidence by the general public anymore.

A lot of CPA’s and CFP’s think that this form of oversimplified calculating does not really serve the needs of most insurance clients today. It’s not very effective. When purchasing a life insurance policy, the vital question is just how much your family or other designated heirs will realistically need when you are gone — and not how much you would like to see them get. An insurance payment should be just one part of a diversified portfolio of financial assets that can be accessed after your demise — such things as property, stocks and bonds, bank deposits, and cash on hand.

What this means is that a person considering life insurance should first scrutinize their current financial status and the status of those dependent on him or her, before deciding on the amount of life insurance to purchase. Life insurance should never be a stand-alone item, divorced from the other financial plans of an individual or a family. It must be integrated into the big picture, financially speaking.

To put it all in perspective, when your finances are properly planned out, usually with the help of a financial expert such as a Ty Stewart from, you will be in possession of a unbiased tool for calculating basic and beneficial financial formulas for your own welfare, and the welfare of those you need to take care of, or have decided to take care of. With today’s advanced algorithms, it’s a piece of cake to figure out your financial liabilities and assets in a matter of minutes, and to continuously update these calculations through the years to adjust something like a life insurance policy to make sure it will always be an appropriate monetary instrument for your wants and needs.