Author: Kevin Lao

5 Reasons To Own Life Insurance In Retirement

Your kids might be financially independent, your mortgage is close to being paid off, and you are getting close to having what you need to retire comfortably. You might be wondering, “Should I own life insurance in retirement?”  So, before you go and cancel that policy, read this post and see if you would be a good candidate to own some amount of life insurance for the long haul.

Basics of term and permanent insurance

basics of life insurance in retirement

Before we dive in, let’s go over the basics of the two primary types of life insurance.  Term Insurance is just that, it’s for a specified term.  This is a cost-effective solution for a temporary need.  Let’s say you have young children, a mortgage, and another 20 years of earned income until retirement.  The death benefit you will need, on average, will be at least 10-16x your gross income (according to the CFP board).  So, if your income is $200,000/year, you will need approximately $2mm-$3.2mm of life insurance. 

Depending on your health, this will only cost you pennies on the dollar (perhaps $1800-$3200/year).  The reason it’s so cost effective is that only 1% of term policies ever pay a death claim, so term insurance is one of the most profitable products an insurance company can sell! 

Permanent Insurance is of course, permanent (mind blown).  There are many flavors out there; whole life (traditional), universal life, variable life, variable universal life, joint survivor universal life, and indexed universal life, to name a few.  If you see the term variable, this means the policy performance is going to be tied to an underlying sub account that can be invested, like your 401k plan.  If you don’t see the term variable, this means the performance is going to be tied to the performance of the insurance company’s general account, which is quite conservative.  If you see indexed, this has a component of a fixed rate with potential upside of a targeted index, like the S&P 500.  The difference between universal and traditional whole life is essentially the cost of insurance schedule.  With traditional whole life, you have a fixed cost schedule at the time you start the policy, and it stays that way for the life of the plan.  With universal, the cost of insurance goes up each year as you get older, but the premiums don’t necessarily go up each year.  The schedule is flexible in that you can stop paying premiums one year (assuming you have enough cash value to support it), start again the next, pay half the premium another year and double the premium the year after.  If you attempted this with traditional whole life, your policy would get cancelled, so don’t do that.  I’m also not advocating you make premium payments to a universal policy like so, but it’s nice to have some flexibility.

I just want to emphasize how important it is, if you have a universal life policy, to review the performance at least annually.  You can request an in-force illustration at any time to show how your policy has performed, and how it’s expected to perform based on fresh assumptions.  I can’t tell you how many times I’ve looked at universal policies that people have paid into for decades that are on the verge of breaking.

The common theme for all permanent policies, if they are structured properly, is the death benefit should be in force for as long as you live.  Additionally, there is a cash value component that you can access while you are living.  This can be done through policy loans or partial surrenders. 

So you might be wondering, why wouldn’t everyone buy permanent insurance and skip the term?  The answer is simple, the premiums can range from 5-15 times more expensive!  For this post, I will mainly discuss the argument of simply owning life insurance in retirement, whether it’s term or permanent is not the point.  However, there are certain arguments I will make that ONLY permanent insurance can solve for.  This is why it’s critical to begin with the end in mind and work backwards.      

Reason #1: You are over the estate tax exemption limits (federal and/or state)

Currently, the federal estate exemption is $12.06mm/person (or $24.12mm for married couples).  If your total estate is valued above the threshold and you die in 2022, you will pay tax on the amount ABOVE the threshold. The tax rates range from 18%-40%, depending on the size of your estate.  Let’s say you had a total estate of $30mm and were married in 2022.  If both you and your spouse passed away today under the current law, you would pay taxes on $5,880,000 at the federal level.  There are also 17 states that have a “death tax,” so be careful where you live when you die as you might owe state AND federal estate taxes (and by “you,” I mean your beneficiaries)!   For example, Massachusetts and Oregon tax estates in excess of $1mm!  As you can see, living in an estate tax friendly state is a big decision point for many retirees. 

This can become problematic for your heirs to pay these large sums of taxes. If you own a closely held business, a real estate portfolio, or a mix of stocks and bonds, you probably want your heirs to continue to enjoy the fruits of your labor and preserve those assets.  Well, if your beneficiaries owe a seven figure tax bill, they might be forced to sell an extremely valuable asset in order to pay the taxes. This is where permanent life insurance can come into play. Life Insurance is a tax free payment of cash to your designated beneficiary. Therefore, instead of forcing your beneficiaries to sell that valuable asset, the life insurance death benefit could be used to pay the estate tax bill. 

*The Tax Cuts and Jobs Act will sunset after the year 2025. The federal exemption is scheduled to revert back to the $5mm/person limit (plus some inflation adjustments). So, while you may not exceed the federal thresholds today, you certainly could exceed them in a few short years.  Plan accordingly!

Reason #2: You Have a Dependent with Special Needs

Life Insurance Special Needs

Children with special needs often require permanent financial assistance. Meaning, their condition won’t make their life any easier as they get older. In fact, quite the opposite. The government provides some financial assistance for those they deem disabled in the form of Social Security Income, Medicare and Medicaid. However, you will likely want to provide additional financial support above and beyond the  government assistance.  While you are alive and working, you will do anything you can to provide that additional financial support. However, if something were to happen to you, how do you address that financial shortfall?

Owning a life insurance policy is a great solution to this problem. You can simply calculate the amount of annual income needed to support the beneficiary with special needs, and come up with an appropriate amount of life insurance to pay out to that beneficiary.  These policies are often owned inside of what is called a Special Needs Trust. This special type of trust allows for the preservation of government support for the child, while at the same time receiving supplemental income from the trust. The longer you live, and the more assets you accumulate, might impact the amount of insurance that you need to own. Ideally you will want some amount of the insurance to be term and some permanent to accommodate the future accumulation of other assets. 

Reason #3: To Replace Lost Retirement Income

 Social Security Income

You might be thinking life insurance is there to replace income when you are working, but how does it factor into retirement income?  For starters, Social Security represents the largest pension fund in the world, and most retirees rely on it for some or most of their income in retirement. When one spouse dies, there is an automatic loss in Social Security income.  The surviving spouse will elect to keep their own benefit, or the deceased’s benefit, whichever is higher.  If a couple each had $24,000/year in social security benefits, this would result in $24,000/year in lost social security income upon the first spouse passing away.  Additionally, after two tax years of filing as a qualifying widower, there could be a widow’s tax given they will have to transition over to a single filer, and potentially pay higher tax rates. 

Furthermore, you might receive a pension from the military or government, or perhaps VA Disability income.  The benefit might be cut in half, or even go to zero upon the annuitant passing away.  Therefore, owning a life insurance policy through retirement can help replace lost social security or other pension income, making the surviving spouse whole and protecting their own longevity.

Reason #4: To Replenish Lost Assets from Long-term Care Costs

It’s estimated that medical costs in retirement will total about $300k for a couple that is 65 years old today, and that excludes Long-term care costs.  The average cost of a nursing home in the US is north of $100k/year (in today’s dollars).  If there was a need for long-term care at the end of the first spouse’s life, this could create a significant drain on retirement assets.  This is especially true if the assets that were used to pay for long-term care came from retirement plans such as traditional IRAs or 401k plans, given the tax drag on withdrawals.  Therefore, owning a life insurance policy can guarantee a cash infusion for the surviving spouse to protect their retirement lifestyle and their own longevity going forward.   This could also be achieved with a life insurance policy with a Long-term care rider, which would allow funds from the policy to be paid in advance for long-term care costs, instead of waiting for the death benefit of the first spouse. Either way, utilizing some form of permanent life insurance in retirement is a great way to protect and/or replenish assets in the event long-term care becomes a financial drain.

Reason #5: To Guarantee a Financial Legacy

I often times hear from clients they have a strong desire to leave assets to their children, grandchildren or even their favorite charity.  Ultimately what they are saying is they don’t want to burn through the assets they have accumulated, but they still want to ENJOY their retirement!  These clients often times have a very difficult time spending their own money in retirement simply because of the fear of running out of money and being a burden on their loved ones.  My clients that own permanent life insurance in retirement can sleep extremely well at night knowing that at least one asset is guaranteed to be there upon their death.  This ends up liberating the client to spend more freely on travel, bucket list activities, charitable giving, and overall results in a more enjoyable retirement lifestyle.

BONUS Reason #6 – Owning Permanent Life Insurance in Retirement as a Fixed Income Alternative

Here is a fun concept, especially in light of today’s bond market!  With the bond index down double digits year to date, many clients are asking about an alternative to bonds.  A few come to mind including an individual bond ladder, fixed income annuities, or even a zero duration hedge strategy.  However, the cash value in a traditional universal life or permanent life insurance policy can be extremely powerful, if structured properly.  If you google “cash value life insurance,” you will see a mix bag of opinions.  For the right client profile (maxing out qualified plans, maxing out Roth conversions, higher tax bracket etc.), there could be a very compelling argument to begin accumulating dollars within a permanent life insurance policy well before retirement.  For starters, it will solve for all of the primary challenges we mentioned previously.  Additionally, it will allow time for cash value to build up inside of the policy.  If it’s structured properly, it can become a liquid asset to draw from during your retirement years. 
You will likely experience anywhere from 4-6 bear markets during your retirement years.  You’ve probably heard the concept, “buy low, sell high.”  In retirement, this involves avoiding selling a depreciated asset for income.  In a market like 2022, both stocks and bonds are down.  If you have cash values built up in a fixed life insurance policy, it’s a viable hedge to allow your riskier assets to fully recover when the market turns around. 

A few last words of advice

Life insurance does get more expensive as you get older, and you also have a greater risk of developing a medical condition that might make life insurance unobtainable. There is no one size fits all when it comes to retirement planning, especially when it comes to using life insurance in your retirement plan. The life insurance industry is quite complex with many carriers and many variations of permanent life insurance. Therefore, I highly recommend you consult with a fee-only financial planner who has expertise in this arena, like our firm! (Yes, I’m quite biased).

If you are interested in learning more about working with our firm, or would like to discuss your financial objectives, book a Mutual Fit meeting with the link below. Also, feel free to share this article with anyone that might find it useful.

Episode 10 – Six Reasons to Take Advantage of Roth Conversions

Are you approaching retirement with the bulk of your next egg in tax deferred 401ks or IRAs? With so much uncertainty on where tax rates might head in the future, you might be wondering, “Should I take advantage of Roth conversions?” They are not for everybody, but in the right situation you could end up saving thousands, or even hundreds of thousands of dollars, in taxes during your lifetime. Additionally, your heirs will also benefit from a more tax efficient inheritance. I hope you enjoy this episode, which includes my interview with Kevin Geddings at WSOS 103.9 in St. Augustine!

Episode 9: The 5 Most Common Estate Planning Mistakes

The number one thing I hear from clients is they don’t want to ever be a burden on their loved ones, and yet, I’ve seen a number of estate planning mistakes over the years.  Fortunately, they never truly get exposed unless something unexpected happens.  These 5 common estate planning mistakes can and should be addressed, and I always recommend seeking official legal counsel from a licensed attorney to do so! 

Episode 8: What to do when stocks are volatile?

Spoiler alert:  The answer is NOT “do nothing.”  

Volatility is a healthy part of investing!  If there was no risk to it, there would not be the upside potential the stock market has provided for decades!  Inevitably when the stock market is volatile, I field a bunch of questions on “what to do next?!”  Nobody is complaining when markets are flying up with no volatility, but once we see that 10% or 20% dip, people start to pay attention.  I decided to record this episode to shed light into what our practice looks like and how we navigate the good and bad markets.  I hope you enjoy it!

Are Financial Advisors Worth It?

In my nearly 14 years in this business, I’ve seen financial advice given by many different professionals. Insurance agents, stock brokers, bank representatives, real estate professionals, next door neighbors and the like. I’ve seen some great advice given, but also some terrible advice. This often times leads to the general public to think “are financial advisors worth it?” This is especially the case now given the lines are blurred between different segments of the “financial services” industry. Vanguard did a study called “Advisor’s Alpha” which I have found is the most helpful and accurate summary of value-added services a comprehensive financial advisor provides. I’ve referenced it to clients and other professionals since 2014 when it was originally published. To summarize it briefly, they outline seven areas of advice that add value to the client’s portfolio by way of net returns annually. They have assigned a percentage to each of the categories which amounts to approximately 3%/year in net returns! In this article, I will highlight some of the key components of their research, as well as put my own spin on it based on my thousands of hours working with clients directly.

What is comprehensive advice?

First things first, not all advisors are comprehensive (and that’s okay). However, this article is specifically for firm’s like mine that are focused on comprehensive advice and planning, and I would argue the 3%/year figure is on the low end. I will get into this more shortly.

Here is a breakdown of Vanguard value-added best practices that I mentioned previously:

The first thing that should jump out to you is that suitable asset allocation represents around 0%/year! This is given the belief that markets are fairly efficient in most areas, and it’s very difficult for an active fund manager to consistently beat their benchmarks. This is contrary to the belief of the general public in that a financial advisors “alpha” is generated through security selection and asset allocation! What’s also interesting is that the largest value add is “behavioral coaching!” I will get into more about what this means, but I would 100% agree with this. Sometimes, we are our own worst enemy, and this is definitely true when it comes to managing our own investments. It’s natural to have the fear of missing out, or to buy into the fear mongering the media portrays. So if you take nothing else away, the simple notion of having a disciplined process to follow as you approach and ultimately achieve financial independence will add 150% more value than trying to pick securities or funds that may or may not outpace their benchmarks!

Before I dive into my interpretation of their study, I want to note that I will be using five major categories instead of seven. Some of the above mentioned can be consolidated, and there are also some value added practices I, and many other comprehensive planners, incorporate that are not listed in their research.

What are the five value-added practices? I use the acronym “T-I-R-E-S”

  1. Tax planning
  2. Income Distribution Planning
  3. Risk Management
  4. Expense Management
  5. Second set of eyes

Tax planning

There are four major components of tax planning a comprehensive financial advisor should provide. The first component is what we call “asset location.” The saying that comes to mind is “it’s not what you earn, it’s what you keep.” Well, taxes are a perfect example of not keeping all that you earn. However, some account types have preferential tax treatment, and therefore should be maximized through sound advice. Certain investments are better suited for these types of tax preferred accounts and other investments tend to have minimal tax impact, and therefore could be better suited OUTSIDE of those tax preferred accounts. A prime example is owning tax free municipal bonds inside of a taxable brokerage or trust account, and taxable bonds inside of your IRA or Roth IRA’s. Another example could be leveraging predominantly index ETF’s within a brokerage account to minimize turnover and capital gains, but owning a sleeve of actively managed investments in sectors like emerging markets, or small cap equities inside of your retirement accounts. According to the Vanguard study, this type of strategy can add up to 75 basis points (0.75%/year) in returns if done properly, which I would concur.

The second component is income distribution. This is often thought of much too late, usually within a few years of retirement. However, this should be well thought out years or decades in advance before actually drawing from your assets. One example I see often is when a prospective client who is on the brink of retiring wants a comprehensive financial plan. Often times they have saved a significant sum of money, but the majority of the assets are held inside of tax deferred vehicles like a 401k or IRA, and little to no assets in a tax free bucket (Roth). This type of scenario limits tax diversification in retirement. On the contrary, someone who has been advised on filling multiple buckets with different tax treatments at withdrawal will have many combinations of withdrawal strategies that can be deployed depending on the future tax code at the time. I have incorporated the rest of the income distribution value-added practice in the next section, but this practice as a whole is estimated to add up to 110 basis points (1.1%/year) in additional returns!

Legacy planning is the third component of tax planning that a comprehensive financial advisor should help with. This isn’t discussed in the Vanguard study, but it’s safe to say a comprehensive plan has to involve plans for your inevitable demise! You might have goals to leave assets to your heirs, especially if you are fortunate enough to have accumulated more than you will ever spend in your lifetime. With the SECURE Act, qualified retirement plans are now subject to the “10-year rule,” and therefore accelerating tax liabilities on your beneficiaries. However, if you incorporate other assets for legacy that can mitigate the tax impact on the next generation, this can save your beneficiaries hundreds of thousands, or even millions of dollars simply by leveraging the tax code properly.

Finally, navigating tax brackets appropriately can be another way a comprehensive advisor adds value. If a client is on the brink of a higher tax bracket, or perhaps they are in a period of enjoying a much lower tax bracket than normal, planning opportunities should arise. If you are in an unusually higher tax bracket than normal, you might benefit from certain savings or tax strategies that reduce their adjusted gross income (think HSA’s, pre-tax retirement account contributions, or charitable giving). If you find yourself in a lower tax bracket than normal, you might accelerate income via Roth conversions or spending down tax deferred assets to lessen the tax burden on those withdrawals. Additionally , considerations on the impact on Medicare premiums in retirement should also be taken into account when helping with tax planning.

As you can see, even though I am not a CPA and I’m not in the business of giving tax advice, helping you be strategic with your tax strategies is part of the comprehensive planning approach. All in, you should expect to increase your returns up to 1%/year (or more depending on complexity) by navigating the tax code effectively.

Income Distribution Strategy

In my personal practice, this ends up being a significant value add given the work I do with post-retirees. A systematic withdrawal strategy in retirement will involve a monthly distribution 12 times throughout the year. This reduces the risk of needing a sizeable distribution at the wrong time (similar to the concept of dollar cost averaging). For a 30 year retirement, this means 360 withdrawals! Most retirees have at least two different retirement accounts, so multiply 360 by 2 for 720 different income decisions to navigate. In my experience, the selling decisions are often what set investors back, especially if they are retired and don’t have the time to make it back. By putting a process in place to strategically withdrawal income from the proper investments at the right time, and maximize the tax efficiency of those withdrawals, this can add up to 1.1%/year in returns alone, according to Vanguard’s study! I’ve also had clients tell me they value their time more and more the older they get. Instead of spending their retirement managing income withdrawals each month, they would much rather travel, play golf, go fishing, spend time with their grandchildren etc. So yes, I would agree with the Vanguard study that 1.1%/year is appropriate for this category, but I would also argue the peace of mind of not needing to place trades while you are on an African Safari with your spouse is priceless! Yes, I did have a client who admitted to this, and no, his wife was not happy! That’s why they hired me!

Risk Management

The major risks you will see during your lifetime from a financial planning perspective are:

  1. Bear market
  2. Behavioral
  3. Longevity
  4. Inflation
  5. Long-term care
  6. Premature death
  7. Incapacity or aging process

Vanguard’s study focuses mainly on the behavioral risk (value add up to 1.5%/year) and re-balancing (.26%/year). As I mentioned earlier, it’s fascinating they rank behavioral risk as the largest value add out of any category! What is behavioral risk? Let me tell you a quick story. A client of mine was getting ready to retire at the beginning of 2020, right as the pandemic reared it’s ugly head. He had 30+ years working in higher ed and climbed the ladder to ultimately become president of his college for the last 15 years. He is a brilliant man, and a savvy business person. When the pandemic hit us, he was terrified. Not only did he see his portfolio drop from $2.5mm to $2.25mm in four weeks, but he was worried this could lead to the next depression which his parents lived through. We had at least a dozen conversations during those weeks about how he was losing sleep every night, which of course was miserable for he and his wife. Finally, in our last discussion he informed me he wanted to sell out of his retirement investments and move to cash. I plead my case in that we had a well thought out diversified strategy, and looking at the math, we had enough resources in fixed income investments to pay his bills for the next ten years! However, I told him it was his money and I was ready to place the trades if that is what he wanted. He told me he would think on it for the next 24 hours. The next day, he called me and said I was right, we had a plan, and he wanted to proceed with sticking to the plan. Well, by the end of 2020 his account not only fully recovered, but it grew to $2.75mm! I am not pumping my chest on performance, but by being the behavioral coach he needed at that time earned him $500k of growth in his portfolio (a whopping 22%).

I can literally share a hundred of these stories not just from the pandemic, but stories from 2008/2009, the dot com bubble etc. The point is, having an advisor you trust that can help you navigate through the ups and downs of the market and tell you what you NEED to hear, not what you WANT to hear is invaluable. Furthermore, it can free up your time to focus on what matters in your life and have the professionals worry about the market for you!

So all in all, I would agree on the 1.5%/year value add for behavioral coaching and .26%/year to help re-balance the portfolio properly. However, Vanguard’s study doesn’t even take into consideration proper insurance planning and estate planning advice a comprehensive advisor gives to their clients which are also value-adds in and of themselves. In that sense, I would argue this category can add up to 2%/year in additional returns to a client.

Expense Management

This is oftentimes overlooked when working with a financial advisor. Much of the public believes working with an advisor will be more expensive! However, many of them are used to being sold high commission investment products or services that are overpriced. However, through due diligence and leveraging the proper research, Vanguard estimates clients should save on average 0.26%-0.34%/year on expenses. From my personal experience, this might even be on the low end. However, for arguments sake and given it’s their research, let’s say we agree with the value-added range set forth.

Second set of eyes

Vanguard doesn’t reference this in their study, but that objective point of view is sometimes necessary to drive positive change. I don’t have any specific data on how to quantify this, but I hear time and time again from clients that they so much appreciate having me as an accountability partner. Think about trying to get in tip top shape without a coach or personal trainer! You might do okay, but you certainly wouldn’t push yourself as hard as you could have if you had a coach or trainer. On the contrary, I often hear from new prospective clients how information overload and the fear of making a mistake has caused a whole lot of inaction, which can significantly hurt returns and performance. Think about a surgeon attempting to perform surgery on their own body! They simply wouldn’t. Not that I am comparing my occupation to a surgeon, but someone working to achieve financial independence would benefit substantially from a trusted third party to help navigate all of the different financial decisions they will encounter in their lifetime. This also could be true for married couples who might have differing views on finances. After all, financial reasons are the #1 cause for divorce in America. If I can help a married couple get on the same page with their financial vision, that is a win for them, no questions asked! Without specific data, I would have to say my gut feel is that objectivity should add an additional 0.5%/year in returns over the duration of a relationship, as well as more self confidence and peace of mind that you are on the right path.

If we tally up our TIRES acronym:

  1. Tax planning = 1%/year
  2. Income Distribution Planning – 1.1%/year
  3. Risk Management – 2%/year
  4. Expense Management – 0.26% – 0.34%/year
  5. Second set of eyes – 0.5%/year

This gives us a total value add range of 4.86% – 4.94%/year in additional returns. My firm’s average fee is roughly 0.85%/year. This is why I get so excited to help new and existing clients. The value you receive, is far greater than the cost to pay me, creating a win-win situation. Now, not EVERY client will experience in additional 4-5% in additional value. Some might receive 2%/year, some might receive 10%/year! However, all of you who have yet to work with a comprehensive planner, or for those of you working with an advisor who may not be doing a comprehensive job, it might be time to reevaluate and see what holes you need to fill. If you are interested in learning how to work with me directly, you can schedule a mutual fit meeting with the button below. Or, you can visit my “Process” and “Fees” pages on my website.

Episode 7: Retirement Income Withdrawal Strategies

I started this podcast as a unique way to deliver informative content to friends, family, clients and prospective clients.  The strategies and concepts are developed based on frequent challenges or questions I come across in my personal practice.  However, this should not be misconstrued as investment or tax advice, and you should consider your own unique circumstances before making any changes. 

Episode 6: 4 Tax Strategies As We Approach Year End

I started this podcast as a unique way to deliver informative content to friends, family, clients and prospective clients.  The strategies and concepts are developed based on frequent challenges or questions I come across in my personal practice.  However, this should not be misconstrued as investment or tax advice, and you should consider your own unique circumstances before making any changes.