Today I’m tackling part 2 of our life insurance in retirement series.
To help, friend and fellow financial planner, Stephanie McCullough stops by.
Together, we cover three main things:
- An academic use case for permanent life insurance to create retirement income
- A step-by-step process for evaluating an existing policy
- Tips and resources for getting conflict-free help
We also break down 1035 exchanges + how you can help family members with old insurance policies.
If you’re ready to get into the technical weeds today and tie a bow on permanent insurance in retirement, this episode is for you!
5-Step Process for Evaluating an Existing Permanent (Whole Life Insurance) Policy
- Identify the type of insurance. Insurance products often have catchy names that don’t always reveal the exact type of insurance you have.
- Uncover the fees, guarantees, and riders. During this step, attempt to see if any of the riders are optional.
- Understand the tax consequences for canceling the policy. In addition, determine if there are any termination or surrender fees.
- Request an in-force illustration. Getting answers to the questions in steps 1-3 can be difficult. An in-force illustration will give you all the information you need. I would also request a copy of the original policy documents so you have the fine print in your hands.
- Go through the 3-step risk management process we discussed in this series. This process will help you evaluate your need for the type of insurance you have and lead you to make an informed decision.
How to Listen to Today’s Episode
Episode Links & Resources:
- 👉 Get Your One-Time Retirement Plan
- Stephanie McCullough
- Jeremy Schneider
- Resources Mentioned:
Life Insurance Part 2: Academic Use Cases, Evaluating Old Policies, Helpful Resources, and More!
Taylor Schulte: Welcome to the Stay Wealthy podcast. I'm your host, Taylor Schulte, and today I'm tackling part two of our Life Insurance in Retirement series to help friends and fellow financial planners. Stephanie McCullough stops by and together we cover three main things.
Number one, the academic use case for permanent life insurance is a retirement income tool.
Number two, how to properly analyze an existing policy.
And number three, tips and resources for getting conflict free help.
We also break down 1035 exchanges and how you can help family members with old insurance policies who may not have a financial professional in their life. So if you're ready to get into the technical weeds with us today and cover everything you need to know about permanent life insurance, today's episode is for you.
For the links and resources mentioned, head over to youstaywealthy.com/141.
Okay, today the main focus is permanent insurance because as mentioned last week in part one, this is where things get more complex and to make sure that we have a constructive conversation.
Today, let's just quickly recap the purpose that insurance serves and what specifically permanent life insurance is. Insurance is a means of protection from financial loss. It's also a form of risk management. And when it comes to managing risks effectively, there's a simple three step process that you can follow.
Step number one, identify the risk, i.e. what is it that you fear might happen.
Step number two, determine how much of that risk you can bear.
And then step number three, if applicable, ensure the remainder.
One of the most popular risks that we insure against is death and permanent life insurance provides coverage for your entire life. Unlike term insurance, it's life insurance. That doesn't expire.
The primary reason to buy permanent life insurance is because you know that when you or another person dies, there will be a sizable financial loss that the survivor or survivors cannot bear 100% of. It doesn't matter if the person dies tomorrow or in 50 years, the death is going to cause a large financial loss, and therefore an insurance company is needed to share in that risk and help with the recovery because of that.
As I shared last week, the most common use cases for permanent insurance are for estate planning purposes. For example, paying a large estate tax bill at death or avoiding probate. It's also used to fund a business buyout or for special purposes like in a divorce and when child support is in the picture. But legacy planning is another use case that Stephanie brought to the surface in our conversation.
Stephanie McCullough: It's so interesting. I always ask my clients how important it is to them to leave a legacy, right? And I mean a monetary legacy to someone, to children, to causes they might care about whatever it might be. And I get the whole range of answers, right?
My kids, you know, I've done my part supporting them, they're on their own from here out. We wanna spend, you know, everything we've got and die with a dollar. Awesome. And other people care very much about wanting to leave something to the next generation, build that generational wealth. No right or wrong, no judgment, but if it is important to you to leave something behind, life insurance, that's exactly what it's designed to do, right?
Permanent life insurance. So if you've got a policy for, I don't know, $200,000 and you wanna leave a hundred thousand to each kid, you can spend the rest of your dollars without, you know, trying to kind of carve out $200,000 to still be there when you pass away.
Taylor Schulte: So estate planning, legacy planning, and special use cases like a business buyout are the primary use cases for needing permanent insurance. That's why permanent insurance was created. And those are the situations that permanent insurance are objectively effective at covering the second use case.
And the more widely known one is permanent insurance being used as a retirement savings and or income solution. Specifically, this use case is positioned to help protect against the risk of running out of money in retirement or to protect against the risk of stock market volatility.
Stephanie McCullough: So whole life insurance is super boring, plain vanilla, you know, it chugs along, making more interest than you're gonna get at a savings account usually, but you know, not nothing to blow the lights out.
However, if you've got most of your assets in the markets, right, stocks and bonds, and we have another 2008, we have a time of really bad market performance or you know, several years where it's kind of moderately down. Tapping your investments means you're gonna have to sell something when it's down perhaps.
So if you have another place to pull money from someplace that's not subject to the markets, and that might be a reverse mortgage, it might be a pile of CDs, it might be cash value in life insurance, then you could fund your spending that year from the insurance pot or the reverse mortgage pot and let your investments hopefully recover a bit.
Taylor Schulte: Now, while there are holistic financial planners out there like Stephanie, who recognized that permanent life insurance is not a solution for everyone and approaches each situation on a case-by-case basis, there are others out there who very convincingly make the case that permanent insurance is the best retirement investment that you could possibly own, and you would be a fool to invest in anything else.
MPI or maximum premium indexing is a permanent life insurance contract with living benefits. Also, the lowest legal expenses lower than an index fund long-term, long-term tax advantages for tax-free retirement income, like a Roth legal protections against liens and lawsuits and creditors, no access penalty of cash now at any age for any reason. Security against the market risk with a 0% floor feature, historical returns of around 7%, and a relock match program that increases your returns up to 15%. Most importantly, retirement income up to four times more over a Roth or the 4% rule.
Taylor Schulte: And to be fair, there are also people on the other side of that fence who passionately say that absolutely nobody should invest in permanent life insurance as a retirement savings tool,
Jeremy Schneider: Never invest in permanent life insurance. These policies come with huge commissions to the insurance salesman and vastly underperform the stock market. I've read dozens of books on personal finance and investing. They all recommend buying and holding index funds. None of them recommend investing in permanent life insurance.
If you need life insurance buy term life insurance, it's like 90% less money and invest the rest of the money in index funds.
Taylor Schulte: You might have recognized that voice. That was my good friend and occasional guest host here on the podcast, Jeremy Schneider. And if you're a longtime listener of the show, you know that I lean towards Jeremy's philosophy when it comes to using permanent insurance as a retirement savings or investment tool. That buying term insurance is appropriate for most people, and permanent insurance is best reserved for the primary use cases that I shared earlier.
That being said, if you're a longtime listener of the show, you also know that I'm an advocate for using evidence and academic research to help us make informed decisions with our money. And one respected academic in particular, Wade Pfau has made a strong case for adding permanent cash value life insurance to a comprehensive retirement plan. You might have caught Stephanie using the term volatility buffer earlier, and that's exactly what Wade's research supports.
In short, Wade regularly acknowledges through his work that one of the biggest risks to retirement is what's known as sequence of returns risk, a risk that the market declines in the early years of retirement when withdrawals begin increasing the chances of running out of money before the end of life.
He notes that there are four techniques from managing this risk spending conservatively maintaining, spending flexibility, reducing volatility when it matters most, and owning buffer assets.
That last technique, owning buffer assets or creating a volatility buffer, as Stephanie put it, is where Wade makes a compelling research back case for cash value, whole life insurance in retirement. He states that one common example of a buffer asset is cash. And while we all know cash is safe, he highlights that the low returns at it that it yields can be a drag on the portfolio over the long term.
As an alternative, he suggests considering a cash-value whole life insurance policy, he also suggests a reverse mortgage line of credit, but that's a topic for another day. With a buffer asset like cash value life insurance, he begins making his case by highlighting that this insurance policy should not be viewed in isolation. And this is important because it applies to so many areas of financial planning and investing.
For example, if you look at bonds in isolation and you compare government bonds to corporate bonds, you will come to a very different conclusion than if you compare each of those asset classes inside of a globally diversified portfolio. If you look at Roth conversions in a vacuum, you might conclude that they are a terrible idea.
But back to cash value, life insurance, Wade acknowledges that it's expensive, which is why it doesn't really look like a great deal for retirees when evaluated in isolation.
But when looked at as one piece of a larger financial puzzle, the conclusion begins to change. Here's a direct quote from him.
Buffer assets can work to protect the investment portfolio from incurring excessive distributions, that helps to manage sequence risk, which allows for the portfolio to maintain a higher long-term balance exceeding the buffer asset costs. This creates an overall net benefit through synergies of better managing the sequence of returns risk.
The cliff notes are that Wades suggests drawing from the cash value in the life insurance policy to maintain retirement income that's needed instead of taking portfolio withdrawals at inopportune times or being forced to cut your expenses. And in his research paper, which I'll link to in the show notes, he tests five different scenarios, one that only involves a cash value policy used as a volatility buffer, and another where the cash value insurance policy is paired with an income annuity to essentially create an actuarial bond using principles from actuarial science.
The more complex scenarios which he labels as integrated approaches are tested against a basic, by term insurance and invests the difference approach and the conclusion of his paper states the following:
We find substantive evidence that an integrated approach with investments, whole life insurance and income annuities can provide more efficient retirement outcomes than relying on investments alone. The recent conventional wisdom of buy term and invest the difference is less effective than many realize when viewed in terms of the risk management needs of a retirement income plan.
Please note that this research paper, his research paper, is almost 30 pages of nerdy academic writing and data tables. And while I just read the broad conclusion to you, he does share some more nuanced conclusions about each of the five case studies and their results. There are a lot of moving parts in this research study, as you can imagine.
So please, please, please don't accept my short summary today as the end all be all. Again I’ll linked to his paper in the show notes for you to read in its entirety, which can be found by going to youstaywealthy.com/141.
Now, while Wade makes a strong case in his, and he's a well-respected academic and PhD, there are some common arguments to take into consideration here.
The first is, like all research papers, the case studies in his paper are hypothetical backtests and may not be indicative of future performance. I think we all know that, but we have to put that out there.
Number two, many assumptions were made about taxes, returns, and fees. And these assumptions may not accurately reflect what actually happens when implemented, especially given the complexity of the products that we're discussing.
Number three, he compares using life insurance to create sustainable retirement income to the generic 4% rule, which as I've discussed here on the podcast, does contain many flaws.
It would be interesting to me to see a follow-up paper comparing the life insurance approach to a dynamic retirement income strategy like guardrails or floor and ceiling.
Number four, at least one of the scenarios he tests includes the purchase of a single premium immediate annuity. These annuities involve you handing over a lump sum of money in return for lifetime income. I.e. you'll never see that lump sum again.
And while they can sometimes look appealing on paper, and they are more widely accepted by financial planners, including myself, most people I work with and talk to, struggle to hand over a large chunk of their savings to an insurance company, especially when legacy planning is really important to them in real life. It's just not always that simple to hand over hundreds of thousands of dollars or even millions of dollars to an insurance company, even if there are some guarantees you're receiving in return.
And then lastly, number five, some conflicts of interest may exist as some have pointed out in some different forms online that Wade Pfau does have connections to the New York Life Center for retirement income at American College, as well as an asset management firm that does have an insurance arm.
That doesn't mean that his research or commentary is wrong, but it can be helpful to take into consideration conflicts of interest if they exist when you're making informed decisions about your retirement and investments. While I respect Wade and his research, I'm, I'm personally not 100% convinced here that a complex income distribution strategy using cash-value life insurance is the most prudent approach.
However, I do think that there's a strong case here, uh, for those that just absolutely cannot bear the risk of running out of money in retirement. Uh, forget legacy planning, forget charitable giving, forget advanced tax planning and Roth conversion for some retirement savers.
They need to leverage every single dollar they have in order to make sure they don't outlive their money. Part of the process for securing their retirement and not losing sleep at night is protecting themselves against risks that could derail their retirement plan.
They know that their plan doesn't have much, if any, wiggle room, and so they can't bear 100% of those risks on their own for others. Including many of our listeners I've spoken to who are diligent savers and have other sources of income like pensions, running out of money is not the number one concern.
And if it is a concern, it often isn't so much of a concern that the risk needs to be shared with an insurance company because let's not forget, there are other ways to protect against stock market volatility and sequence of returns risk. Cash value life insurance is one potential solution, but there are dozens of others to consider, many of which can be adopted easier and at a lower cost.
Remember, when you buy an insurance policy, you are paying for the protection that they are providing you there. There's no free lunch here. Whatever benefit or guarantee that's being pitched to you is baked into the fees and economics of the insurance product. And that's not a knock on buying insurance or the insurance company, it's just a fact.
We have to remind ourselves that at their core, these are insurance policies issued by insurance companies and those insurance companies need to get paid. Sometimes it's wise for us to spend money on insurance and sometimes it's not. We all need to go through our own insurance evaluation process to determine what makes the most sense for us and our retirement plan. There is no one size fits all solution.
Speaking of an evaluation process, while you may not have the need to go out and buy a new life insurance policy today, many retirement savers have policies that they've purchased years ago, decades ago. And one of the more common questions that Stephanie and I both agreed we get is what do I do with this old policy? Should I keep it, should I get rid of it? So let's break down a process for handling old insurance policies because it isn't always as simple as keep it or cancel.
Stephanie McCullough: You wanna look at a statement, right? And, try to understand what is this right? What type of insurance is it? Does it have any cash value to it? And sometimes people are attracted by like, yeah, if you surrender this and there's cash value, you could get a check, but maybe keeping it is a better deal.
So, you know, I always suggest that you want to talk to someone who knows, right? Perhaps the agent who sold it. Maybe that person isn't around anymore. Sometimes it's better to call the 800 number on the statement because those folks are not usually incentive to sell you anything. Um, but you wanna find out, okay, what is, what does this look like?
There's something called an enforce ledger that you can ask for, which is kind of a projection going forward. So you could say something like, all right, if I stop paying premiums on this policy, can you send me the enforce ledger?
What does it look like? How long would the coverage last? Or if I pay, you know, a certain amount per year or per month, what might that look like? So that's one piece of it because you know, maybe it does make sense to have some, some death benefit for you, and if you don't have to pay for it anymore, that could be a benefit.
But then you also wanna understand what the riders are, and a rider is just an optional feature to an insurance policy. Very often there are things like, um, an accelerated death benefit. So if you were to get a dread diagnosis or being diagnosed with a terminal illness, you may be able to access your death benefit or your loved one could before passing away.
That could be money that could be very handy at that time. There's policies that have long-term care benefits to them so that if you are, you know, um, certified as needing care with the activities of daily living, you might be able to access the death benefit or more.
So you wanna understand what are all the options and the riders on this policy, and then sometimes there's the option to swap it over to something else, right? There's something called a 1035 tax-free exchange that you could potentially do. I just helped a client with this last year.
They had an old policy, it had built up some decent cash value, they didn't really wanna pay for it anymore, but they were worried about long-term care. We did an exchange buying one of these hybrid life and long-term care policies.
And I know, Taylor, you've talked about long-term care on the podcast before and you know, it was a one-time purchase, so she never has to pay any more premiums and she's got now some long-term care coverage. So like that was a nice little bonus for her.
And there's another crazy idea. You could gift the policy to a charity, right? And, and either continue paying premiums as an ongoing gift or if it's, you know, what they call a paid-up policy, meaning you don't have to pay anymore. You, right? I mean, maybe you're gonna write a $1,000 check to that charity or they get $50,000 when you pass away. They'd probably be really thrilled to get the $50,000 whenever that might be.
Taylor Schulte: Taxes are an important consideration as well. A, a number of the cash value policies that I've worked through with clients over the years have had sizable unrealized capital gains. Meaning if you were to just blindly sell them, you would be looking at a large tax bill and that tax bill, if not planned for, could come at an inopportune time creating another problem for you to solve.
Stephanie McCullough: If you get to the point where your cash value is higher than your cost basis, meaning the sum of the premiums you've paid over the lifetime of the policy, and you surrender the policy, you will pay tax on the growth beyond the cost basis.
But you know, again, there are other options, right? If you, if you can keep the policy, you can keep it alive and use that cash value, you can withdraw up to your cost basis and then take a loan from it. Um, but again, you wanna understand what you've got and some of these policies, the way they're built, the cost of insurance keeps going up every year. So it's going to eat away at your cash value over time.
And the ones I've looked at are, you know, the older uni-variable universal life policies versus kind of the whole life policies where the cost of insurance is kind of, you know, more fixed. So you kind of do have to dig in a little bit and understand the mechanics of what's going on inside.
Taylor Schulte: To recap and summarize, there are three options you have when dealing with an old policy. One, keep it, two, cancel it, or three, replace or exchange it. And to better help you determine what's best for you, here's my five step process for evaluating an old policy, which I'll also include a written version of in the show notes for this episode, which you can find by going to youstaywealthy.com/141.
So here's the five-step process for evaluating an old policy.
Step one, identify the type of insurance. Insurance products often have very catchy names that don't always reveal the exact type of insurance that you have. So step number one is just to get clear on the exact type of insurance you own.
Number two, uncover the fees and any guarantees that are attached, including any of the writers during this step. I would also try to identify what guarantees and writers are optional and what are required.
Step number three, identify and understand the tax consequences for canceling the policy in addition to any termination or surrender fees.
Step number four, since finding all of the answers to the questions in those first three steps can be difficult. I highly recommend ordering what's known as an inforce illustration, which will give you close to everything that you need. I would also see if you can get your hands on the fine print of the original policy documents, and I love Stephanie's suggestion of calling the 800 number on your statement versus the insurance agent directly in an attempt to get objective information and answers to your questions and also mitigate the chances of any sales pressure.
Lastly, number five, with all the information about your policy in your hands, you can use the three-step process that we've talked about from managing risks to evaluate your need for the type of insurance that you have and work towards making an informed decision.
Remember, you have three choices. You can keep it, you can cancel it, or you can replace or exchange it. Now maybe you're not quite ready to take action, but you want a trusted advisor in your life to keep tabs on the policy that you have. If that person is a licensed insurance professional, you can add them as an agent of record to the policy. But if they're not, for example, maybe it's a CPA or an attorney or even a fee only firm like mine that doesn't sell insurance, you can get them added as an authorized third party.
A simple form is all that's required, and this authorization allows the person you choose to receive duplicate statements and contact the insurance company on your behalf to learn more about the policy, to ask questions and even order enforce illustrations. Another scenario where this comes into play is if you're helping out a family member and overseeing their finances and investments.
Maybe they don't have a financial advisor and they're leaning on you to help them. In that case, they could add you as an authorized third party just like they would add a CPA or attorney. You don't have to be a licensed insurance agent to be added as a third party, and it's just a great way to keep a second or third pair of eyes on these sometimes complex policies that often get neglected.
Lastly, if you do need professional help with evaluating an old insurance policy and hiring a financial planner is just not of interest to you and you don't think an insurance agent can be objective. One resource to consider is a gentleman by the name of James Hunt. His website is evaluatelifeinsurance.org, and he's a retired actuary who spends his time these days charging an hourly fee to analyze life insurance policies.
I've engaged with him in the past, but I don't personally work with him, so I can't vouch for his services. However, he does seem to maintain a good reputation with the Vanguard Bogleheads Community, White Coat Investor, and Clark Howard. So if you're familiar with any of those three or involved with those communities at all, it might be worth reaching out to learn more if you just want some quick help by the hour.
Alternatively, if you do work with a financial planner, they should be well-equipped to analyze your existing policies and or help shop the market for a new policy without any conflicts of interest.
In fact, one insurance company we work with is called Low Load Insurance, and they specifically work with commission-free firms like ours. So while they support us and our clients and help us secure insurance policies, we don't get paid any commissions when helping our clients secure policy, which helps to keep the cost low.
So ask your financial advisor about them if you have one, as well as an up-and-coming competitor called DPL Insurance, which shares a similar model. And last, but absolutely not least, there's my good friend Stephanie McCullough to consider. And in addition to being well versed in insurance, she's also a fellow retirement podcast host.
Stephanie McCullough: We call it Takeback Retirement. I was a child of the eighties and when I was in college in the late eighties, we had these takeback of the night marches to protest against violence against women. So I kind of was thinking it was like a little nod to my fellow Gen Xers and boomers perhaps.
Really it's speaking to women kind of 45 and up who might be facing whatever retirement means to them on their own. And what I've discovered with my clients over the years is that there's really no one they can talk to about their money stuff. You know, maybe they don't have as much as they think they have, or maybe they have more than most of their friends. Either way, it's really uncomfortable to talk to people about money.
So, you know, I love working with my clients, but I wanted to have a bigger impact. So try trying to get the word out there, provide some useful information, and interview some interesting guests. We have a series called Real Retirement Stories of Women who've been through retirement in one form or another, and they're kind of sharing their learnings along the way and how they got there.
Taylor Schulte: She's also the owner of a retirement planning firm in Pennsylvania called Sophia Financial.
Stephanie McCullough: I was told by my friend who's half Greek, that Sophia means Wisdom and Greek. So it's really focused on empowering women to make wise financial decisions, very much holistic financial planning from the perspective, you know, what's important to you, what are you trying to do in life? Then let's line up this stuff called Money to support that.
Taylor Schulte: A big thank you to Stephanie for joining me today and sharing her wisdom. If you want to learn more about Stephanie, I'll be linking to her podcast, take Back Retirement, as well as her firm, Sophia Financial, in the show notes, which can again be found by going to youstaywealthy.com/141.
As always, if you have any follow-up questions, if there's something that you are hoping we would cover on this topic today that we missed, please send me an email to firstname.lastname@example.org. I read and respond to every message and your feedback, questions and comments continue to help make this show even more valuable.
Once again, you can grab the show notes for today's episode by going to youstaywealthy.com/141. Thank you, as always, for listening, and I will see you back here next week.
Episode Disclaimer: This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.