Many of us have probably thought at one time:
Will my savings last through retirement?
How will the volatile financial markets impact my long-term retirement goals?
When financial markets don’t perform well, a plan of continuing to take out yearly retirement distributions (qualified funds) will force you to sell when the markets are volatile. And market downturns at the beginning of a retirement can have a long-term negative impact on your retirement funds.
Let’s take a look at what are: Qualified and Non-Qualified funds.
Qualified accounts: are retirement accounts such as a 401(k), 403(b) and IRA. You use pre-taxed money to fund them.
Non-Qualified accounts: are brokerage and savings accounts. You use after-tax dollars to fund them.
With your qualified funds the federal government lets you delay paying taxes so you can build a solid nest egg. To ensure you’ll eventually be taxed the federal government has created yearly RMDs (required minimum distributions) that must be transferred out of your qualified plans and taxed as ordinary income.
How to calculate your RMD:
Your RMDs will be calculated by dividing the value of each qualified account by a life expectancy factor, as determined by the IRS. You will have the flexibility to take your total RMD (adding up all your individual RMDs) from either a single qualified account or a combination of qualified accounts. And as you grow older, your life expectancy factor decreases resulting in your RMD growing each passing year.
The ages where you must start taking RMDs are between 72 and 75, depending on the year of your birth. And the kicker is you are required to take out yearly RMDs each year whether you need the income or not.
Adding up all your sources of retirement income might trigger higher taxes on your Social Security benefits and high-income surcharge on your Medicare benefit.
To mitigate a tax hit in retirement, some pre-retirees choose to begin withdrawing money from their tax-deferred accounts after they turn age 59½. These early withdrawals would slowly reduce the balances in their qualified accounts; resulting in a smaller RMD and taxable income when they turn the appropriate age to start liquidating RMD funds.
Keep in mind that your RMD withdrawals are considered ordinary income and will factor into your tax bracket when you start taking them.
What alternative form of retirement income can provide strategically needed cash when the markets are not performing well for your qualified funds?
I discovered years ago one possibility through reading Mark Teitelbaum’s article: “Smooth Sailing on Uncertain Waters” for the American College in 2014 that still holds true today. He broaden how I view the functionality of cash value of Life Insurance and the power of policy loans.
A Whole Life Insurance Policy can add a conservative element to your retirement income/tax shelter strategy that may help steady the ups and downs of the inevitable market trends that occur over time.
Adequately funding a Whole Life Insurance policy provides dual benefits:
having a death benefit during your working years and
at retirement providing reasonable cash to tap into as needed.
A Whole Life Insurance policy becomes a cash asset over time because a portion of your premium payments are allocated to your policy’s cash value.
This cash value can:
grow tax-deferred,
is guaranteed and
does not fluctuate based on market conditions.
Over time the cash value earns interest and once you’ve accumulated enough cash value you can take federal income-tax free cash or policy loans from your Life Insurance policy.
There are two ways you can access cash:
taking withdraws up to your total premiums paid into your policy and
policy loans when adequate cash has accrued and you have passed the MEC 7 pay test.*
*For the first 7 years of a Life Insurance policy Congress created the MEC Test “7 pay test”. Congress was concerned that individuals, in the initial years of owning a Life Insurance policy, would overfund them and benefit from exceeding legal tax limits. This limitation expires at the end of the 7 years as long as no material changes occur.
Adequately funding a Whole Life Insurance policy may provide an individual with the right amount of cash to help offset the down markets during retirement. Rather than being in automatic and withdrawing your yearly retirement funds from your qualified plans in a down market, think about:
strategically taking a policy loan following a down market year, helping provide time for retirement funds to recover and grow.
How do RMDs change the retirement withdrawal equation?
If you choose to start taking yearly retirement withdrawals, let say at age 63, RMDs won’t be required for a few years.
During that pre-RMD period there might be a year, when markets are down, where you want to turn off access to your qualified funds following a down market year allowing those funds to recover and grow. In that following year you could withdraw the needed funds from your Whole Life Insurance policy with a policy loan.
Once you reach the RMD age of having to withdraw yearly funds from your qualified plans you may have options.
Each yearly retirement withdrawal consists of: yearly RMD and the balance of the retirement funds you would like to withdraw for that year.
Yearly Retirement Withdrawal = yearly RMD + balance of yearly retirement withdrawal
When the markets have positive growth there will be no need to take out policy loans.
A year, when you see markets drop, in the following year you could allow those funds to recover and grow by:
just taking out the RMD from your retirement funds and
the balance of your yearly retirement withdrawal from a policy loan.
On the other hand, if you have other sources of non-qualified funds and the markets are in positive or negative territory and you would rather not sell your RMD portion of your retirement withdrawals for that year, because you feel those securities will grow in value. You can avoid selling your RMD assets for that year, through what is called an “in kind” transfer.
This is where the RMD securities in a qualified account are transferred into a brokerage account; paying ordinary income taxes on the value of the assets transferred. With an “in kind” transfer you avoid selling the RMD securities allowing you to hold on to securities that you feel are growing in value.
In the article Smooth Sailing they illustrated, with Tom age 65, how accessing Whole Life Insurance policy loans following down markets Tom avoided selling into market losses.
Tom purchased a modest Whole Life Insurance policy in his 40s. Reaching age 65 the death benefit of his policy was $500K with cash value at $233K. Tom planned to draw $70K a year from retirement funds.
With that modest Insurance policy he had sufficient cash to help protect his $1M retirement funds at age 65 through policy loans, allowing his retirement funds in down markets time to recover and grow to over $3M by age 85.
Timing, we can’t always control the financial markets.
We can’t control the timing of the financial markets during our retirement years. But, with adequately funding a Whole Life Insurance policy will make it possible for you to take selective policy loans following down markets years, lessening the impact of selling into market losses.
Lets start the conversation and
explore the dynamics of
including a Whole Life Insurance Policy
in helping protect your retirement savings.
Debra K. Bedell
Insurance - a great Hedge against Risk.