by Michael Goodman
Cash value life insurance is one of the oldest and most secure financial tools you can use. It can be used to protect a family from the death of the primary earner, it can be used for estate planning, and the tax-advantaged buildup of cash in the policy can be used for many different purposes, accessible without income taxes or penalties at any age.
But the one knock I hear most often about life insurance is that it’s too expensive to be used for building a retirement income. My answer to this is that – let’s look at the numbers.
The Numbers
If you have $500,000 in a qualified plan (401k, 403b, IRA, etc.) and it’s all invested in an Index Fund with annual costs of just .23% per year, you’re paying $1,150 in annual fees (assuming those are the only fees you’re paying). Your growth or losses are going to pretty much mirror the growth or loss of the mutual funds that you’ve selected. Now take note of this, as your account grows, the amount you pay in fees each year will also grow. That charge of .23% applies to everything in the account every year, just like an annual property tax. In addition, it’s applied to any NEW money you add to the account. If you grow the account to a million dollars, the fees will be $2,300 per year. If you have more money in the account, or if your fees are a higher percentage, then the annual costs will be much higher. So, if you have 30 years until retirement, you’ll pay that fee on the entire amount each year, on all the money you deposited, and on all the growth each year. Is that a bargain?
On top of all this, if the account is not a Roth account, all the money you take out later will be taxable, every penny, as regular income. So if you take out a consistent amount each year, like a regular income, not only will you pay taxes on all of it, that income will also probably cause your Social Security income to become taxable. Yes, you saved money on income taxes when you made the deposits and delayed the taxes on the growth, but it’s likely you will pay back all of those tax breaks in five years or less, then will continue paying taxes for the rest of your life.
The Alternative – Life Insurance
By comparison, the amount you pay for life insurance will depend on your age, health, and the amount of the death benefit. It is not based on the amount of cash value in the policy. What’s a typical life insurance policy cost? If you’re young, it might be just a couple hundred dollars a year. If you’re approaching 60 and in good health, it will still probably be less than $1,000. In addition, the money you take out of the policy in retirement will be tax-free, and you’ll still have a death benefit that pays out (income) tax free to your family or other heirs. How well can this work out? If you’re 25 years old now and can afford to put $200 a month into the right kind of policy (an IUL), you may be able to withdraw over $90,000 per year, tax-free, starting at age 66.