I know, I know. You think about life insurance all the time, don’t you? You are fascinated by all the ways it can serve you and your family. You discuss it at cocktail parties. No? I guess that might just be me.
All kidding aside, one reasons why you may not, is that you are not aware of the ways life insurance can help you work towards your financial goals while you are alive as well as protect and provide for your family.
As a holistic financial advisor, I work with clients as a wealth advisor but I also work in the insurance and risk mitigation areas as well. I work through a detailed process that is looking to find ways to mitigate risks while building wealth with each client’s current situation, personality and goals. While Life insurance is not an investment, it can serve retirees and have a large impact in a retirement income plan. With pensions mostly a thing of the past and the average person living longer; building a sustainable retirement income strategy is of the utmost importance.
Wade Pfau, a professor at The American College for Financial Services, has done much research in this area and has written a well-known white paper called, “Optimizing Retirement Income by Combining Actuarial Science and Investments”. Wade shares, ‘For retirement income, we must step away from the notion that either investments or insurance alone will be serve retirees. More emphasis is needed on the basic forms of insurance products and how they may behave as part of an integrated retirement income plan.”[1] I could not agree more. Let’s look at the risks and how life insurance might help.
Risks That Can Affect Your Retirement Income:
- Longevity Risk:
- How long do you need income for? Since you don’t know, you should plan for longevity.
- What if your spouse dies prematurely and you live a long life? You will lose one social security check each month and possibly a pension, yet many costs stay the same. How does this change things?
- Investment Volatility and Sequence of Returns Risk
- Today you may have an 80% stock, 20% bond portfolio but once you start to take income from your account, can you handle that amount of risk? What happens when you have a down year?
- Do you understand how the sequence of the returns you get on your investments, once you start to take income, can drastically change your results? In a 2021 Forbes Article, the author shares a typical $100,000 investment over 5 years. They have two scenarios of returns. The first scenario has returns of 25%, 15%, 5%, -5% and -20% respectively in the five years. The second scenario has the same returns, but in the reverse order. Both scenarios the compounded annual return is 2.78% should there be no withdrawals. However, if there is a withdrawal each year of $10,000 the results are very different. In the first scenario with positive returns early on, the portfolio would have more than $70,000 left. The second scenario only has $47,000.[2] This is just after 5 years. What could happen over a 25-year retirement?
- Inflation & Tax Risk:
- How much purchasing power will you lose due to inflation or possible increased taxes over time?
- Health & Long-Term Care Risk:
- How much of your nest egg can you afford to put aside in case of a health issue or a LTC need?
It is because of these risks that there has been much debate on what is a ‘safe withdrawal rate’. How much can be taken out without a large risk of running out of money. Over the years, there have been different thoughts on this but most research is pointing to a withdrawal rate around 4%. Morningstar published an article in December 2022 listing a 3.8%.[3] If you are surprised at how low this is, you might need an updated strategy.
How Can Permanent Life Insurance Act As A Risk Mitigating Asset?
With longevity risk, having a death benefit could be structured with the goal of replacing their social security or pension, allowing you to continue to have the same income, even if there is a premature death. What if you live a very long time and you need more income? Permanent life insurance can provide a cash value that might be tapped if needed.
Permanent Whole Life could help with investment Volatility and Sequence of Returns Risk by providing cash value that could be used in years when your investments are down. Once the market recovers, you may have the option of taking additional funds from your investment and replacing the dollars in your cash value. By building a strategy like this, you may be able to avoid withdrawing when your investments are distressed while in retirement.
A permanent Whole Life policy could help mitigate Tax risk since the tax laws are favorable. It may mitigate inflation by having guaranteed growth in the cash value and can offer an annual dividend that can help increase that growth.
As for Long-term Care risk, many life insurance companies now offer policies with the ability to use a portion of your death benefit to pay for long term care; tax free, should you qualify. You will need to confirm the company you are applying with offers this benefit and understand how the benefit works as well as how you qualify, since companies’ offerings vary.
There are a lot of moving parts when building retirement income strategies. I would recommend you are getting advice from a financial advisor who has experience and is licensed in wealth management as well as life Insurance. I would also ask them about their process to help identify if this strategy may work for you and to what extent.
I hope you can see how coupling a foundational product of permanent life insurance along with a well thought out selection of investments, could help in retirement. I hope you also got a few tidbits for conversation at your next cocktail party!
Note: At Empowered Financial Strategies, we understand how important it is to have a good foundation of basic financial knowledge. We offer educational workshops in areas of insurance and investing with this end in mind. If you have a group or association and would like us to speak, please reach out to us at Contact (empowered-fs.com)
At Empowered financial, we Listen to Learn and Educate to Empower.
About the author:
Carolyn Humphrey is a Financial Advisor, with licenses in areas of Life, disability, health and Long-Term Care Insurances as well as a number of Finra licenses allowing her to work in various areas of Wealth Management. She has earned the RICP®, (Retirement Income Certified Professional), from the American College. This designation helps Financial Advisors learn about how to guard against the 18 risks that clients face in retirement. She has also earned the WMPC®, (Wealth Management Certified Professional), which is designed to help Financial Advisors build efficient portfolios for goals-based investing. Carolyn has also earned the CLF®, Certified Leadership Fellow, which has helped her in various leadership positions such as being a national trainer as well as a manager of a team of advisors. She has been married and caring for rescue pups since the early 1990’s and has been an avid Buffalo Bills fan forever.
The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security or insurance product.
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[1]https://static.fmgsuite.com/media/documents/9b364d00-595a-4b3e-92e4-a531e608aa7c.pdf
[2]https://www.forbes.com/advisor/retirement/sequence-of-returns-risk/