Mike and Betty
For this week's column, I'm borrowing from my associate Wayne Averett, who is a financial professional in Tupelo. We have worked together for ten years, and sometimes… well, I just steal his ideas. He knows and he's good with it.
Retirement income planners are often faced with the daunting task of helping retirees in their early 60s guarantee income for life. Since the fastest growing segment of the population is 85 and older, it is common for many retirees to have to live for 30 years or longer on the proceeds of the retirement plan they put into place while they were still working.
Let's use an example to illustrate the planning challenge mentioned above:
Suppose Mike and Betty are a healthy 62-year-old married couple.
Both Mike and Betty are approaching retirement and have calculated that they will have sufficient income in retirement to meet expenses with some left over. Their primary intention with their 401(k) and other savings is to leave it to their children.
Even so, a life insurance needs analysis indicates the need for more permanent life insurance that will be guaranteed to leave more tax-free money behind for the surviving spouse and children.
Mike and Betty also want the other benefits offered by permanent life insurance, such as the Accelerated Death Benefit. This benefit will allow them to access up to 75% of the life insurance certificate's death benefit in case either one of them becomes terminally ill and has a year or less to live.
In Mike's case, he has a $1,000,000 20-year term life insurance plan whose term is coming to an end. Fortunately, he has a small amount of permanent life insurance but not nearly enough to cover his future needs. Mike's wife Betty is in virtually the same boat with a $500,000 20-year term life insurance plan whose term is ending and only a small amount of permanent life insurance.
All too often, those planning for retirement would let their term life insurance policies lapse under the conventional thinking that “this is too expensive to keep going” and “my kids are grown and my spouse will inherit my retirement so I don't need this anymore”.
Let's flip this scenario around and see if Mike and Betty's retirement accounts can be put to work to offer a solution with life insurance that is guaranteed to provide more tax free income in those later years of retirement – their 80s and 90s (and possibly beyond…) – when it will be needed the most.
Mike - At age 62, when his $1,000,000 20-year term life insurance expires, he can convert it to a guaranteed universal life insurance certificate for approximately $17,500 in annual premium. So how will this new and large premium be financed? The annual amount needed can be provided by placing about $350,000 from one of Mike's IRAS in a Single Premium Immediate Annuity (SPIA). Using this strategy buys Mike an additional $17,500 in annual income from his retirement nest egg and use it to pay the premium on the conversion of $1,000,000 of life insurance! On top of that, when Mike dies Betty will receive the income left over in the SPIA.
Betty - At age 62, when her $500,000 20-year term life insurance expires, she can convert it to a guaranteed universal life insurance certificate for approximately $7,500 in annual premium. So how can Betty pay this new larger premium? The annual amount needed can be provided by placing about $120,000 from one of Betty's IRAS in a Single Premium Immediate Annuity (SPIA), which will pay her $7,500 per year. Using this strategy enables her to
take a smaller amount of taxable income from his retirement nest egg and use it to pay the premium on the conversion of $1,000,000 of life insurance! On top of that, when Betty dies Mike will receive the income left over in the SPIA.
Why does this strategy work? Even though this strategy works best for a narrow group of people who are retirement age, healthy, and with ample retirement accounts, it is worth considering because it enables a married couple to take a relatively small amount of taxable income and turn it into a comparatively large, guaranteed, and tax free life insurance benefit.
Other things to consider…since many life insurance companies will convert term policies to permanent ones up to age 70 without underwriting, consider purchasing a large amount of term life insurance to take you up to that point in time.then when you reach age 70 convert the term life insurance to a permanent plan. Doing this enables you to keep the largest death benefit for the lowest premium cost as long as possible.
Consider trying to pay the premiums from income withdrawn from mutual funds. If you have the risk tolerance to try this, a recent hypothetical from Franklin Templeton shows that 20 years ago you could have invested $250,000 in their Franklin Income Fund, withdrawn $25,000 each year ($500,000 total over 20 years!) to pay the life insurance premiums, and then had a small amount left over. Compare this premium payment option to placing the $470,000 total above that Mike and Betty paid for SPIAS to generate this income. If you can't decide which option is best for you, you can use part of each one as a hedge. Either way, you can't go wrong using these amounts to pay for $1,500,000 in life insurance benefits.
Another side benefit that can be looked into (if the numbers were bigger) is that the life insurance can be owned by a trust and then not included in your estate when http:// www.myjourneytomillions.com/articles/simple-explanation-of-the-federal-estate-tax/ calculating your estate taxes.
As with anything, the situation is the boss, and your financial professional can help to determine if these strategies, or others, are right for you and your family. Give him/her a call and discuss the options NOW, before those options diminish or disappear.
Barbara Runnels Coats, MBA, FICF, RICP, Modern Woodmen of America Financial Representative