One of the benefits of being a member of NAPFA (the largest professional organization of fee-only financial advisors in the country) is the ability to tap into the collective knowledge of my fellow members. I recently saw a question posted by a fellow member in the daily email forum for questions and other information that we all receive. The question was:
I have a 38-yr old dentist client who forwarded me an email from his insurance agent trying to sell him a universal life insurance policy for retirement income purposes. This guy claims if my client puts in $10k for 10 years, at age 65, my client will get $26k in tax free income for 20 years (until he is 85). Sounds too good to be true. Has anyone seen this “scheme” before?
My answer to him (and the responses of a number of other members) was that we had seen this; it’s a familiar “song” in the insurance sales world.
A case study from my own experience
A client who is a high earning professional in his late 40s had purchased a variable policy with a $2 million death benefit. The client is pretty financially savvy and the agent is someone who I know, respect, and have used with clients in the past. This policy was sold to the client prior to my involvement, however.
The premise was that the client would fund the policy for 10 years and at that point the cash accumulation would be enough for the client to be able to fund a significant portion of his retirement by taking out money on a tax-free basis.
The reality some five years into this was that the underlying investments had not performed anywhere near what was needed via the original assumptions in the policy illustration. At this point the client would have needed to fund the policy into his early 60s and with a significant amount of money.
I had an outside consultant review the policy and he suggested the client stop paying premiums and wait until the policy’s surrender charges went away in about five or six years. At that time we could look at doing a 1035 (tax-free) exchange into a low cost variable annuity or some other vehicle. In the meantime there was enough money in the policy to fund the death benefit. This was the best alternative among several lousy ones.
While the $2 million death benefit was not excessive for this client, the sole reason for buying the policy was to provide himself and his family with a supplemental retirement benefit over and above what he could do via his company’s 401(k)/profit sharing and via IRAs.
What’s wrong with life insurance as an investment or retirement savings vehicle?
As mentioned above often these policies have very optimistic investment assumptions. If the underlying investments don’t live up to those assumptions it’s likely the amount available to fund retirement will be less and/or you might have to make larger premium payments for a longer period of time than anticipated. The death benefit of the life insurance policy itself could also be reduced.
Once you begin taking money out of the policy it is vital that you stay on top of the amount withdrawn. If you take out too much money from the policy it could lapse and trigger an expected tax bill. A good agent or company will generally monitor this.
These policies often have hefty underlying expenses which are not always fully disclosed. This eats into your investment returns.
While the example cited above involved a high-earning professional variations on this same theme are marketed to middle income prospects as well.
What are some alternatives to using insurance?
- Certainly I would suggest that anyone considering this type of arrangement first fully fund any company retirement plan. If you are self-employed make sure that you have looked at a Solo 401(k), a SEP, or other alternatives first.
- Make sure that you have funded an IRA.
- Look at a LOW COST, NO SURRENDER variable annuity such as those offered by Vanguard and others.
- If you own a business look into retirement plans that might let you put additional dollars away for yourself such as a cross-tested profit sharing plan or cash balance pension plan.
- If you are a corporate employee in mid to upper management you might have access to supplement non-qualified plans. These allow you to defer extra amounts over and above the limits of the 401(k). A note of caution, non-qualified plans are subject to the claims of any creditors in the event that your employer encounters financial difficulty so tread carefully here. Also be aware that you generally cannot role these over to an IRA or a new employer’s plan when you leave the company (or ever), you must take the money out and pay taxes at that time.
If approached by someone trying to convince you to use life insurance as an investment vehicle for retirement or any other purpose be very leery and ask many questions. Make sure this is a good deal for you and not just for the rep trying to sell you the policy.
Please feel free to contact me with questions about retirement plans or your retirement planning needs.
Check out our Resources page for links to a variety of tools and services that might be beneficial to you.
Photo credit: Wikipedia
I worked in the life insurance industry for five years and would always cringe when I would see reps sell these as retirement vehicles when that’s really not what they’re meant for. There are so many other options available out there, but I think many times (not always though) the rep is just selling something to someone that is not as informed as they should be.
John thanks for the comment. I am a fan of life insurance, but like most other products it has a core usage and that is to provide a death benefit. When reps start to invent “new and better” ways to sell more of it often this is not in the best interests of those being sold to.
Good post, I thinking sharing examples like yours will help people understand that there is a dark side to what the sales people are saying! I have a life “rule” to not combine financial products that serve completely different purposes, because typically one if not both of them do a poor job. So I avoid permanent insurances in favor of a separate term policy and a separate investment. This way I can pick the best policy and best investment to suit my needs and then not have to change both when my life changes!
Thanks Andrea well said. I totally agree about not combining financial products. Many folks need life insurance for a death benefit, but I’ve rarely seen an example of life insurance being a good investment.
Yes agree with you guys. I also find the post very valuable. It will really help people to understand the value of insurance. Well its not all about some particular insurance I think all insurance is plays very important role in our life. People should know about the major and important parts of insurance. It is the one of the must thing to buy life insurance.
Thanks for your comment.
I agree with you that life insurance should not be used as a retirement savings vehicle in most situations. But with high income earners who aren’t eligible for Roth IRA’s and are already maxing out their employers retirement plan I think life insurance can be a solid addition to their retirement savings. I too have seen the “familiar song” you mentioned above, as a matter of fact, I see it all too often but that doesn’t mean it cannot be a good “investment” in certain situations. In general I am a buy term and invest the difference type but I would encourage all planners to look at over-funding(up to the MEC limits) Univeral Life Insurance for high-income clients.
Ryan thanks for your comment, I agree. No solution or product is right or wrong all of the time, that’s where a qualified advisor can add value.
this is a great article. i wish more people would talk the truth about this type of life insurance. always best to buy term insurance and invest the rest in a tax sheltered vehicle.
Thanks for your comment Rick.
Mr. Wohlner attempted to answer the question: “Is life insurance a good idea as a retirement saving vehicle?” I was very excited to read this article, but was equally disappointed by the was roger prove his point. I am relative new to this industry and do respect anyone who has a CFP designation. However, the case study he used to prove his case was bad, and more a reflection of a bad advisor not a bad strategy.
For example, anyone who is using insurance as a retirement plan should not focus on the death benefit. A DB of 2 million was the wrong place to start. Also this client is in his late 40s, probably 49, so the mortality cost would be very high and therefore consume premium needed for cash accumulation. If that client needed that level of protection he should have taken a policy designed for that.
The fact that the policy did not deliver should not be a reason to disparage the strategy. Insurance agents use suitability standards and so like any other investment, the product has to be suitable.
One of the basic questions a financial advisor should ask a client is ” what are you trying to achieve?”
Thank you for your comment Orland. In my opinion the client (who as I indicated purchased this policy before he was a client) would have been far better served in trying to meet his objectives by looking at other retirement savings vehicles as opposed to the life insurance policy. While the level of the death benefit was appropriate given his situation, there are better vehicles to have provided for this. As a financial advisor, life and other types of insurance are valid planning tools, I am just opposed to life insurance sales people who feel that selling a policy is the solution for all financial problems. Sadly In encounter this situation far too often.