Today, I want to discuss using a life insurance policy for retirement funding. There are plenty of people out there selling this as a sound financial strategy to avoid the penalties of early withdrawal from a more traditional retirement plan. Let’s go over this and see if a life insurance policy is really the best way to fund your retirement.
This podcast is part of our Personal Finance for Business Owners series.
So, there is a strategy out there that goes by many names. It’s sometimes called a Life Insurance Retirement Plan, or a LIRP. It’s also called a President Secret Account or the 770 Account. The funniest term I ever heard on this was a 702J Retirement Account. It all means the same thing: we want you to buy a life insurance policy for retirement. The idea is that the life insurance generates a cash value so that you can take money out of the retirement account tax-free when you’re ready to retire and that it outperforms the idea of buying term and investing the difference.
When I started out in finance, I was trained to sell these LIRPs and had to do it to keep my job. We used to run reports and use them to “prove” to top potential customers that a life insurance policy will outperform a buy-term-and-invest-the-difference concept. What buy-term-and-invest-the-difference basically means is that you’re going to buy the 20-year or 30-year term insurance and the difference between the whole-life premium or the term premium gets invested into your retirement account or into a non-qualified account. We had to sell Life Insurance Retirement Plans back in the day. Are they bad? No. Are they the best? Well, times have changed.
What you have to remember is that things are changing super-fast. We have investments today that we didn’t have five years ago. We have strategies because of the new tax code that we didn’t have two years ago. At this point, for a business owner, I just don’t believe that using a life insurance policy for retirement is a strategy or philosophy that you should buy into.
I have an illustration that I asked a life insurance agent to provide me. I’m just going to read you the numbers off of it. This is for a 40-year-old nonsmoker who needs $1,000,000 worth of life insurance coverage and this particular policy has a 5.5% ASSUMED rate of return. Is this a good rate of return? Depends on how the investments were to act. The premium for this policy is $5,920. What this example shows me is that from age 40 to age 50, if I put in $5,920 a year, that I have paid $59,200 after ten years. I’ve paid that money for these ten years for $1,000,000 in life insurance. IF SOMETHING HAPPENED TO ME, the insurance company would pay out the death benefit. But here’s where the sales pitch comes into play. They’ll tell you that if you put in this money every year, that after 10 or 20 years you’re going to have a cash value that you can access for retirement planning.
Here’s the math. After 10 years, you’ve paid in $59,200 and your total cash value should be around $26,000. That’s less than half. So, the commission on this type of policy is about $15,000 (I’m estimating). Now, if you’re using this for accumulation, there’s not really enough there to do anything with. If you run that out to 20 years, it gets even crazier. After 20 years of “investing,” you’ve paid in $118,400 and the cash value might only be $93,000. That’s a cash value that still doesn’t even match the premium paid. Looking out to 30 years, the policy should have finally tipped. You’ve paid in $177,000 and your cash value might be $200,000. So, in 30 years of “investing,” you’re only likely to see a gain of $23,000.
Now, let’s contrast the above example with an investment account investing the same $5,920 annual investment with a 5% rate of return. I dropped the .5% to represent an investment fee to give a realistic comparison. After 10 years, the account value could be over $78,000. If you’ve paid in $59,200 and your account has over $78,000, that’s almost a $20,000 pickup, folks. Compare that to the life insurance at 10 years, where you likely lost over $30,000. Right off the bat, after 10 years of buying a low-cost term insurance policy and investing a comparable premium into the market, you could end up with an amazing difference of over $50,000.
Here’s where it gets exciting. Looking out to 20 years, the life insurance had a possible cash value of $93,000 for your $118,000 in premiums. Your investment account should have over $205,000. That’s almost DOUBLE what you’ve paid in. If we run it out to 30 years, remember that your life insurance account had a potential cash value of $200,000 that cost you $177,000. In the investment account, you could now have $412,000. Now, this is only assuming a 5% rate of return. If we assume just a little better the return could soar. This example obviously isn’t a guarantee nor does it account for the low-cost term insurance premium you would pay. The term insurance premium would reduce the potential account value a bit, but not near as dramatically as the whole life policy example above.
Probably the biggest reason that I’m so against this is that there are so many alternatives that we can use to accomplish the same goal as the old sales pitch. We can use retirement accounts. You could put money into a ROTH 401k and grow a lot of money tax-free. A married couple could put $36,000 into a ROTH 401k. If you don’t know how to do that, reach out to us. Call me and say “Justin, help us. We don’t know how to do tax planning and we need someone who will work with us” and we’ll help you. There are a lot of retirement options we can use.
If you’re maxing out your 401k and want to save more, we could set it up like a cash balance plan. I had a client this past year, under the age of 40, who was able to put over $300,000 into a pretax cash balance plan who got over 96% of that money back into his personal account. Now, tax benefits vary based on your specific situation, but the point is that there are a LOT of options out there that we didn’t have a few years ago.
|10 Years||20 Years||30 Years|
The talking-heads on the radio and television, like Suze Orman, Dave Ramsey, Clark Howard, and Robert Kiyosaki, all agree that you DO NOT use life insurance as a retirement account. I agree with them. These accounts aren’t always bad though. If you’ve maxed out your actual retirement accounts and you’re looking to sock away money in a sheltered product for creditor protection or use it for wealth transference with an estate plan, then these accounts can make sense. But if you’re hearing the old sales pitch from Whoever Mutual, run run run.
So, to answer the question definitively: should you purchase life insurance to fund your retirement? NO! Absolutely not. This idea that buying a life insurance account is going to give a lot of money when you’re ready to retire just isn’t so. I have seen, many times but certainly not always, the insurance companies increase their insurance cost, and that causes the account to decrease in value over time. I’ve seen that. There are many other things that can happen over time that ultimately mean that what is on the illustration IS NOT GOING TO HAPPEN. I’ve been doing this for 20 years and I have yet to see an illustration that matches the reality of what happens after a few years because THINGS CHANGE.
Buying a life insurance plan to fund your retirement simply isn’t a logical strategy. The choices we have available to us for investments have changed greatly, and there are just too many better ways to accomplish that goal. If you’re considering the future and trying to decide how to make the most of your retirement, you don’t have to do it alone. There are a lot of options for you out there that can help you reach and maybe exceed your retirement goals. Get with your financial advisor or reach out to us – we would love to help you get there.