Commonwealth Financial Network® - Independent Broker/Dealer

Wealth Replacement in Retirement Planning
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Author: Neil Krause

When you and a client draw up plans for the client’s retirement, you might typically put in place a strategy that counts on him or her accumulating enough wealth to supply an income stream for the retirement years. Together, you determine some "magic dollar amount" that your client must amass in order to produce the income stream.

But the key to the effectiveness of this strategy is that equity markets must cooperate when your client is ready to retire. Moreover, once retired, for the method to work, your client must not invade his or her principal; otherwise, there’s a chance that he or she may outlive the income source. Upon your client’s death, the surviving spouse may not have enough money to meet living expenses.

USING THE GUARANTEED DEATH BENEFIT TO FUND RETIREMENT
Simply put, a big problem with the strategy described above is that it is so inflexible. I’d like to propose a better approach—one that is easy to implement but surprisingly underused in the retirement planning arena: the guaranteed death benefit.

Purchasing permanent life insurance affords clients the flexibility to invade their principal, knowing that the principal will be replaced because of the insurance policy’s guaranteed death benefit. If a client were to follow this approach, he or she would have several options1 from which to choose to fund retirement living expenses:

Spend down principal. This option is the most obvious choice. The guaranteed death benefit gives a "permission slip" to tap into principal because it allows for replacement of the principal spent. If the client has a $1 million guaranteed policy, he or she could spend $1 million of other assets; upon death, the value of those other assets would be replaced and ready for use by the surviving spouse or other beneficiaries.
Invest in an annuity. Between age 65 and 70, for example, a client could invest in a $1 million annuity, which, when annuitized, would pay out $76,000 to $80,000 annually for as long as the client lives. This option bets that the client will live longer than the 10 years it would take to recoup the entire investment. If he or she lives fewer than 10 years, the $1 million death benefit kicks in for the client’s spouse or other beneficiary.
Establish a charitable remainder trust (CRT). If a client has a philanthropic bent, this is a great option. A CRT works basically like an annuity. The client decides to bequeath some financial assets to a favorite charity and turns over a predetermined amount to a trust created for this purpose. The trust pays the client a fixed income amount annually, based on the funds in the trust. The client would, in turn, use income from the trust to purchase permanent life insurance. When the client dies, the charity keeps the remainder of the trust fund, and the client’s family gets the insurance death benefit. It’s a win-win-win situation.

All three of these options have tax advantages, as does the tax-free guaranteed death benefit that the insured’s beneficiary will receive. More importantly, these options allow you to help clients increase their income potential during retirement.

IS TERM INSURANCE A BETTER OPTION?
But if insurance is the answer, does it make more sense to buy term insurance instead of permanent insurance on your client’s life because the premium cost is lower and your client can invest the money saved? Probably not. Although this seems like a great idea in theory, most clients won’t follow through on investing the savings. In addition, term insurance very rarely pays out—only 1 percent to 2 percent of term policies actually pay a death benefit. So, your client will not have the freedom to invade principal because it is highly unlikely that his or her beneficiary will collect on a death benefit.

Moreover, if your client buys permanent cash value life insurance, as recommended above, he or she is in effect buying term insurance (for life) and investing, too. Additionally, he or she can access funds tax-free through withdrawals and loans, allowing still more flexibility. (Please note that loans and withdrawal amounts must be repaid or they will be deducted from the death benefit amount.)

DIVERSIFICATION IS AN ADDED BENEFIT
Purchasing permanent insurance has yet another benefit: it serves as a form of diversification. Your client can buy a whole life policy that also has a guaranteed cash value component, available as a rider for an added cost (in addition to the guaranteed death benefit). During a down market cycle, such as the one we have been experiencing recently, your client will have the comfort of knowing that his or her whole life policy is not moving in the same direction as other invested assets. It makes it easier for him or her to stomach the downturn—making your job a bit easier, too.

TIMES LIKE THESE CALL FOR NEW STRATEGIES
Economic downturns often spawn the need for new strategies. Advisors who are willing to change their ways and evolve with the industry are the most successful. The key is to understand that your clients’ risk tolerance will change with the fluctuation of the markets. A client who was once willing to take on a lot of risk may think differently after his or her invested assets have diminished by a significant amount. But one thing the markets cannot affect is the guaranteed death benefit. Use it to your advantage, so clients can potentially benefit from better markets in the future without worrying about how much will be left over for their beneficiaries.

All guarantees are based upon the claims-paying ability of the issuing insurance company.

Source:
1. "Permission Slip," CPA Wealth Provider, January 2007.

Neil Krause is an insurance product consultant. He is available at x9161 or at nkrause@commonwealth.com.