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Life Insurance as an Alternative to a Non-deductible IRA – Reason #3: Cushioning a Market Downturn


The coming tax season is a perfect time to help your high-income clients assess the options available for their additional savings.

In a series of 6 back-to-back blogs we illustrate 5 key reasons why cash value life insurance can be a powerful savings vehicle when compared to other retirement income sources, especially a non-deductible IRA:

  1. Replacing the Post-Retirement Income Gap
  2. Diversifying Taxes at Retirement
  3. Cushioning a Market Downturn
  4. Guarding Longevity
  5. Maximizing Social Security

Today we flesh out Reason #3


The order of returns doesn’t much matter when accumulating savings. But at retirement, when distributions are taken, the sequence of return really matters. Take a look at a $1,000,000 investment over 25 years. The returns in these two scenarios are exactly the same. The only difference is that they go in reverse direction:

Scenarios 1-2

Accumulation Phase 2

Now look at distributions taken from each scenario:

Scenarios 1-2-2

Accumulation Phase

It’s important to beware of the depletion rate, especially during a market downturn. The withdrawal rates– and not market returns– determine how long retirement funds last. Traditional money management strategies– like asset allocation and diversification– will do little to extend the life of retirement funds during the de-accumulation stage if clients are withdrawing funds too quickly. For instance, if a retiree purchased an investment for $10 per share and it is now $8, (s)he lost $2 per share or 20 percent. To break-even, a 25 percent return is needed. When you are withdrawing from your retirement funds after a downturn in the market, you create a permanent loss in the portfolio. If you have a 20 percent loss, and take a 4 percent withdrawal, you’ll need a 32 percent gain to recover.

How Life Insurance Can Help Cushion Market Dips. Having an alternative source of supplemental income, like cash value life insurance, can help provide a cushion during a market downturn and can go a long way in giving an investment portfolio time to recover. Although some cash value life insurance policies are dependent on market returns, some of these policies have a floor so that while you may not earn interest, your policy may be protected. Other types of policies are not subject to market conditions at all.

How would this work? In a market downturn, instead of taking distributions from a retirement account that has been affected by a “hit” in value, clients can take withdrawals from a strategically designed cash value life insurance policy on a tax-favored basis, while the investment account has time to recover. By considering cash value life insurance for protection needs during the working years, clients will position themselves to have access to a tax-advantaged income source during a market downturn at retirement.

It’s important to consider, too, that the distributions from the life insurance are not considered reportable income. Since Medicare Part B premiums are based on income and can be considerably high (as much as $460/month currently), supplementing income with cash value life insurance may help to keep those premiums down.

Qualified Plans/
Traditional IRA
Cash Value
Life Insurance
Non- Qualified
Deferred Annuity
No No No No No No
No No No
No Mandatory
Tax- Deferred
Income Tax-
Free Death
No No No No No No
No Tax Penalties
for Early
Early withdrawal penalty Early withdrawal penalty Early withdrawal penalty Early withdrawal
penalty may apply
No Contribution Limits Contribution limits Contribution limits Contribution limits
Cost of Insurance Charges No No No No No
Market Risk Depends on product
Long-Term Care Coverage No No No No No
Non- Reportable Income No No No No No No

The moral of the story here is to ensure that high-income earners diversify their tax situation in retirement by contributing to a number of savings vehicles that will not only help their income tax situation today, but also at retirement.

Like a non-deductible IRA, life insurance is funded with after-tax contributions and offers tax-favored distributions. However, unlike the non-deductible IRA, life insurance offers death benefit protection during the working years, access to the death benefit during lifetime to cover long-term care expenses (when a rider is attached) and has no contribution limits. In addition, the policy may be protected from the claims of creditors and the distributions from the life insurance are non-reportable. These features can be very appealing to many, especially physicians, attorneys and personal service companies.

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In case you missed it…
Life Insurance as an Alternative to a Non-deductible IRA? 5 Reasons Why – Intro
Reason #1: Replacing the Post Retirement Income Gap
Reason #2: Diversifying Taxes on Retirement Income

Stay tuned for our next blog post…
5 Reasons Why: Life Insurance as an IRA Alternative
Reason #4:  Guarding Longevity

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