401(k) Retirement Accounts Or Indexed Universal Life Insurance?

Posted on August 3, 2011 by Michael

401(k) Retirement Accounts Or Indexed Universal Life Insurance?

Many Americans face a difficult choice when planning for their futures.  The government has endorsed the use of individual retirement accounts (IRA), the 401(k) plan, and other “tax qualified” retirement accounts as vehicles to build cash value that can be used in retirement to supplement our savings, home equity, and social security earnings.  But relatively few people are considering the use of indexed universal life insurance for the same purpose.

You don’t have to look hard to find people who believe that “you should only buy term insurance” and “insurance can’t fund your retirement”, especially since insurance is paid for with after tax dollars.  All of the tax qualified retirement accounts allow money to be deposited tax free in the year they are earned.  So the question is whether or not there’s any reason to even consider indexed universal life insurance for retirement purposes.

Let’s look at the arguments in favor of life insurance but keep in mind that I’m a licensed seller of real estate and life insurance.  I’m not an accountant, a lawyer, or a securities dealer.

1. Permanent life insurance (whole life, universal life, indexed universal life, etc) builds a cash value over time that grows tax-deferred, similar to the qualified retirement accounts.

2. If you die before reaching age 100, life insurance provides a tax-free payment to your beneficiary.  With the qualified plans, if you are unmarried, your 401(k) is often taxed as regular income to your beneficiary in the year received, a huge tax burden.

3. The cash value that builds in permanent insurance is an asset that can be accessed free of income taxes or penalties using zero-cost policy loans.  The loan does not need to be repaid until you die.  These loans can be used for any purpose, such as college expenses for your kids, car repairs, vacations, etc.  Funds in  qualified retirement accounts normally cannot be accessed prior to age 59 1/2 without incurring a 10% penalty and income taxes.

4. Premiums for indexed universal life insurance can be increased to allow the cash value to grow larger and faster and there are few limitations on the amounts.  In many tax qualified retirement savings plans, there are limitations to how much you can deposit.

5. The cash value in a life insurance policy can grow without any requirement to take money out.  This gives you the option to let your funds build.  In qualified plans, you are required to take out a minimum amount beginning at age 69 1/2 and every year thereafter.  The government doesn’t want to wait for its share.

6.  When you use the cash value for an income stream in retirement, you will normally receive the money free of income taxes.  When using a qualified plan for retirement, the income is fully taxable by the state and federal governments.  Some people think that the tax deferred status given to their deposits is a big deal but, if you do the math, you’ll find that the meager taxes saved prior to retirement are often paid back in less than four years in retirement. In addition, most retirees have fewer tax deductions since the kids have left and the house is paid off or has a low balance.  If you live a normal lifespan, you’ll find that you’ve paid $100s of thousands of dollars more in taxes than if the same money had been put into a life insurance policy.

7. The cash value in an indexed universal life insurance policy grows with little risk.  The growth in these accounts is normally tied to an index like the S&P500.  When the market value goes up, your account goes up (to a cap).  When the market goes down, your account stays the same (it has a floor).  You cannot lose value due to the market and you never need to make any decisions about the account.  During the “lost decade” from 2000 to 2010, when the S&P500 essentially stayed flat, users of indexed life accounts earned an average of over 9% per year because they only participated when the market went up, not when it went down.  Use of a qualified plan requires the worker to either become an expert on investing or trust his account to the skills of strangers.  Since the market has often gone down in recent years, this means the balances in many retirement accounts has gone down by large amounts.  This can be devastating to somebody planning to retire soon.

8. When properly set up and funded, an indexed universal life insurance policy will provide a tax-free income for life that does not vary.  Many users of qualified plans have found that their accounts do not provide the income they hoped for (either because the balance did not grow as much as they expected or they underestimated the income tax burden), or the money runs out before their life does, requiring them to find jobs at places like Walmart and fast-food restaurants, where they are much older than their co-workers, or to rely on family or charity to make do.  This is a tragedy that is happening to more people every year.

So, what do you think? Have I been unfair to the qualified retirement accounts?  Are there benefits to using a 401(k) that an indexed universal life insurance policy does not have?  Please add your comments and opinions down below.

 

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Term Life Or Indexed Universal Life Insurance?

Posted on July 21, 2011 by Michael

Term Life Or Indexed Universal Life Insurance?

Should you buy a term life policy or an indexed universal life insurance policy? Some years back, a guy named A. L. Williams attracted a lot of attention and made a lot of money by encouraging people to cash in the value of their whole life insurance policies, buy term life, then invest the rest. The entire campaign was based on two ideas, that term life is less expensive than whole life and you can get a better return on your investments than the insurance companies were paying. I wasn’t an agent at that time, so I can’t say if it was true or not. But I don’t believe it’s true now.

Term life is considered “pure insurance” because it only pays for a death benefit if somebody dies. If two healthy people who are the same age each buy the same face value of insurance, the one who buys a term life policy will pay a lower premium for their coverage than the one that buys an indexed universal life insurance policy – for the first year!

Term life is considered temporary insurance. It must be renewed on a regular basis, either yearly or at the end of a fixed period of time like 5-years, 10-years, etc. No matter what the renewal period, the premium will change for the next period and it will always go up. At the end of the period of coverage, the buyer must renew or the coverage is done. There is nothing left. So, if you buy term life for 20 or 30 years and don’t die, then you’re out the cost of the premiums.

But an indexed universal life insurance policy is different. The premium is larger to allow the build-up of cash value and the policy is considered permanent insurance because it’s designed to cover you until death or age 100, whichever comes first. The premium always stays the same unless you want to add more to the cash value. The longer the policy is in force, the larger the cash value becomes. If you ever need to use some of the money you’ve paid, in the case of an emergency for example, you can borrow against the cash value. If you live to be 100 and have not died, then the entire cash value (less any outstanding loans), will be paid back to you at that time, offsetting virtually all of the premiums you paid. If you choose, you can have the cash value paid out during retirement, to supplement your other income, while maintaining the death benefit to age 100. So your long term cost is now zero. The longer you own the policy, the less expensive the universal life policy is when compared to a term life policy.

The key is the cash value and there have been some big changes in the methods used for building this value. The most important one, in my opinion, is the use of indexes. In 2011, most indexed universal life insurance policies are tied to the value of the S&P 500 Index. That means, when the S&P 500 goes up, the value of the indexed life policy goes up (to a cap). But when the S&P 500 goes down, the value of the indexed life policy stays the same (it has a floor). This allows the owner of an indexed universal life policy to share in the growth of the stock market without being exposed to the volatility and risk. During the “lost decade” of 2000 – 2010, when the S&P 500 stayed essentially flat for 10 years, the holders of many indexed accounts actually enjoyed average growth of 9% per year. In addition, the cash value compounds free of income taxes, which promotes tremendous growth over extended periods. These features make an indexed universal life insurance policy very important for many people, especially those in their 20’s and 30’s, who have a lot of time to build a retirement nest egg. When comparing these policies to other retirement vehicles, there is one other thing to keep in mind. Not only do you get a good rate of return and safety, you can access the funds in retirement free of income taxes, thanks to zero-cost policy loans.

So, should you buy a term life policy or an indexed universal life insurance policy? The question is a little more complicated than I’ve implied in this article but, for most people, the indexed universal life policy will be cheaper in the long run, and will produce a better rate of return than most people can get in the market by themselves.

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Does Deferring Taxes to Retirement Make Sense?

Posted on June 30, 2011 by Michael

Does Deferring Taxes to Retirement Make Sense?

One of the basic premises of putting money into a tax-deferred vehicle like an I.R.A. or 401(k) is that you are likely to be in a lower tax bracket after you retire.  The presumption is that your income during your retirement years will be lower and the tax rates will be the same.  But does that really make sense?

Currently, thanks to the tax cuts pushed early in the G.W. Bush years, income tax rates are pretty low by historical standards, especially the rates for capital gains.  The big question is – Will they stay that way?

Governments at all levels (federal, state, local) are currently having trouble paying their bills.  The combination of a bad economy coupled with exorbitant pay and benefits given to government workers has led to a lot of deficit spending that cannot continue. This has caused most government levels into draconian spending cuts in education, court services, and benefits for the poor and disabled.  It seems unlikely that these cuts can increase.  What’s the alternative?  Tax increases!

It seems to me that we’re likely to see major increases in tax rates in coming years.  In some states, it’s not easy to raise tax rates (like California), but I don’t think we should ever underestimate the resolve of politicians if they think they’ll take less flak for raising rates than for cutting benefits.

So, if tax rates are likely to increase in the future, does it make sense to defer taxes from the present, when rates are lower, and pay them later, when rates are higher?  Logically, it doesn’t make sense unless the difference between your current income and your income at retirement will be large enough to offset the difference in tax rates.

It used to be that retirement meant something different than it does today.  When you retired, your house was paid off, you had few debts, if any, and you expected to live a quieter and less active life.  From everything I read today, that’s no longer the case.  For many of us, we’ll simply spend a little less time working while exploring our “bucket lists”.  To the “baby boomers” who are now retiring, a major drop in income is not in their planning.  Which brings us back again to the question – should you be deferring taxes from today to the future, when income tax rates are likely to be higher?  To which I would add – Is there a valid alternative?

I believe there is.  There are products available today that will allow you to save after-tax income from today, compound it free of income taxes at a good rate of return, then spend it later without income taxes.  Think of your current income as a small box.  Imagine your savings from that small box, compounded tax free over a period of 20-25 years.  Your savings plus interest after that period of time is a large box.  The question is – would you rather let the government tax the small box now or tax the big box at higher rates later?

What is this product that will allow your savings to grow free of taxes, then be spent tax-free later?  Equity indexed universal life insurance.  This is not your daddy’s life insurance!  For more information and a no obligation consultation, give me a call at 626-215-3750.

 

 

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