The best laid plan requires a hedge. And this certainly applies to retirement planning.
Even if clients are saving enough for retirement, there remain 5 roadblocks to a well-intentioned retirement plan that need to be addressed:
- Rising Healthcare Costs. Healthcare will likely represent the largest expense during retirement. The estimated out-of-pocket medical costs for a couple age 65 today over their retirement is approximately $260,000, according to the Fidelity’s 2016 Study on Retiree Health Care Cost estimate. The same Fidelity study estimated the cost to be $245,000 a year prior, illustrating the magnitude of the annual escalation in costs. Medical inflation will increase this amount even further. Consider that the general rate of inflation is 1%, while the medical costs inflation rate is running at more than double that rate, or 2.49% annually. Consider, too, that the purchasing power of a dollar can decline over the years. It becomes harder to maintain a lifestyle when income doesn’t increase. For example, if someone retired back in 1989, the buying power of a dollar in 2015 has been cut to almost half.
- Living Too Long. A chronic or terminal illness can cost thousands of dollars each year. It’s tough to predict what those costs will be or when a client will begin to incur them. However, taking into account their family history, clients can get an idea of what may happen—though this certainly is not a given. Chronic diseases like cancer, heart disease or diabetes are caused by a combination of factors that include genes, behavior, lifestyle and the environment. It helps to know what the risks are and how to mitigate the risks– and the costs– when you are fortunate enough to live longer than expected.What are the chances you will become chronically ill and require long-term care? Take a look at statistics on longevity alone:
|Live to Age 90||Live to Age 95||Live to Age 100|
|Men||4 in 10 Men||1 in 7 Men||3 in 100 Men|
|Women||1 in 2 Women||1 in 4 Women||7 in 100 Women|
Based on 2015 Basic Valuation table, Nonsmoker, Select & Ultimate mortality rates. American Academy of Actuaries and Society of Actuaries
The key question a client must answer, then, is “How long will I live?’ In other words, retirement can last for more than 30 years, even with a chronic illness. Will sources of funding be there, especially if there are unexpected expenses that arise? Consider the following unexpected expenses:
- Change in tax code
- A natural disaster
- Care over an extended period
- Significant financial help adult children may need from parents.
- Market Volatility. If the stock market has a downturn while the client is taking income, this downturn will have a dramatic impact on the amount of time money will last. Having sources of income to tap that are not tied to the market will help to preserve principal during market dips.
- Taxes will most certainly reduce income in retirement. Many people overlook the impact of taxes, incorrectly assuming that tax rates will be lower then. While we don’t know for sure what income tax rates will be during retirement, we can consider the impact they have. Take a look:
|Timing of Taxes Based on Retirement Income Source|
|NOW- During Accumulation||LATER- During Retirement or at Distribution||Likely NEVER|
|Stocks||IRAs||Life Insurance Death Benefit|
|Mutual Funds||Annuities||Life Insurance Cash Values|
|Bonds||401(k) or 403(b)||ROTH IRAs/401(k)/403(b)|
|Social Security||Health Savings Accounts for medical expenses|
Diversifying taxes across retirement sources is critical to extending principal and managing uncertainty of tax rates at retirement. That is, many sources of retirement income are subject to taxes. Pensions and 401(k)s, for example, are 100% taxed since they accumulated on a pre-tax basis. Interest from CDs is taxable annually, as is interest earned on some bonds. Although capital gains taxes on dividends earned from stocks and mutual funds can be lower than ordinary income taxes when the investment is held for longer periods of time, we don’t know what those capital gains rates will be in the future either. Even Social Security income may be taxable depending on a client’s total income.
Therefore, it is important to offset and manage taxes or avoid them altogether. It’s important to note that accessing certain assets may, in fact, raise your tax bracket so it is important to take this into account when planning as well.
- Low Interest Rates. Finally, consider that low interest rates could make some of the sources of your retirement income anemic. The amount of interest a client earns on retirement funds will have a direct impact on the amount available to support his or her lifestyle. Consider that $100,000 will generate the following gross income based on hypothetical interest crediting rates, and depending on the asset, may be income taxable:
|Interest Income on $100,000 Retirement Fund based on Crediting Rate|
|Hypothetical Rate||Annual Income|
What To Do?
Clients would be wise to answer the following questions when planning for retirement income:
- What are my chances of becoming chronically or terminally ill?
- How can I prevent a long life from becoming a financial burden?
- How will I cover gaps in income when interest rates are low?
- How do I address the impact on my principal when the market dips?
- How will I address the impact of taxes on my income?
Permanent Life Insurance offers a flexible solution that addresses all of these concerns.
Permanent life insurance is flexible and versatile. It provides a death benefit to help loved ones financially if the client dies while the family still relies on him or her. And, if designed and funded properly, the cash values can provide a flexible source of tax-free supplemental income in retirement with no penalties for distributions made prior to age 59 1/2, unlike qualified plans or IRA money. And the available cash values of a life insurance policy can be used in any way the client chooses.
The cash values of a permanent life insurance policy:
- Can be accessed on a tax-free basis if withdrawals are structured properly
- Can be used as a source of tax-free retirement income during times of market dips to preserve other sources of retirement income
- Can be used to offset taxes that need to be paid on taxable income from other sources
- Can be used to offset out-of-pocket healthcare costs like insurance deductibles and co-insurance
- Can help maximize Social Security income by creating a bridge to taking Social Security later
- Distributions are non-reportable so that total income is reduced for purposes of Medicare Part B that looks at total income to calculate premium.
Moreover, the cash value life insurance policy may include a chronic illness or long- term care rider which accelerates the death benefit to cover chronic illness or long-term care expenses. The death benefit can also be accelerated to help cover a terminal illness. Some newer policies also include a critical illness rider that provides a one-time lump sum amount from the policy to cover expenses connected to a critical illness like cancer or heart disease. Note that when cash values are used, or the death benefit is accelerated to provide these living benefits, the death benefit will adjust accordingly.
Permanent life insurance delivers across a lifetime and is sufficiently flexible to eliminate roadblocks during the retirement years.
Latest posts by Lina Storm, CLU®, ChFC®, MBA (see all)
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