Should you buy life insurance to fund or augment your retirement savings? Life insurance retirement-planning solutions make sense for some, but they are not right for everyone. However, more people may be faced with that question, thanks to recent news from the Department of Labor.
Emerging from a months-long regulatory ping-pong match, the DOL’s fiduciary rule is now scheduled to take effect on June 9, 2017, according to an opinion piece in The Wall Street Journal by Labor Secretary Alexander Acosta. The Trump administration had issued an executive order that delayed the rule, but Acosta wrote that there was nothing to stop the rule from being implemented.
During this regulatory back and forth, many brokers and investment professionals had already re-evaluated what products they will recommend to clients in the future. They will no longer be selling expensive, and well-paying (for them, of course), variable annuities. Additionally, many investment options being introduced will pay them on a fee basis rather than a commission basis, so investors’ retirement savings could take a hit as the fees add up over time.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
As a result of these firms switching their models, they may be recommending life insurance products more often as a retirement-planning tool.
So, if your financial adviser or a life insurance salesperson ever presents this as an option, proceed with caution, because it might not fit your needs. Life insurance and retirement-savings plans generally have two separate purposes. Retirement planning funds your life post-work; most life insurance policies fund your loved ones’ lives — post you.
Life Insurance Pros
There are two primary types of life insurance: term life insurance and whole life insurance. Term life insurance provides coverage for a specific time period, and has a specific premium that is decided based on the age and health of the insured. Term life insurance is also called “pure” life insurance because its only purpose is to insure against death — it generally does not accumulate additional value and is designed to financially protect dependents in the case of a policyholder’s premature death.
On the other hand, so-called whole or permanent life insurance (permanent if payments continue or it is fully funded) contains a life insurance death benefit and a separate component that builds up cash value. In variable life insurance policies, the cash value is invested in sub-accounts that the policyholder is usually able to select. In indexed life insurance policies, the cash value grows based on a pre-established index.
The advantage in this type of policy is the ability to withdraw or borrow against the cash value. These are the funds that can help with your retirement, a child's college or major home improvements. Distributions through borrowing (from yourself) are 100% tax free, vs. many other types of retirement funds. However, interest rates on these loans are high (at around 7%-8%) and failing to pay off the loans or withdrawals lowers your death benefit.
Life insurance salespeople like to portray variable policies as the Swiss Army knives of insurance products. Future income, projected growth, tax benefits, death benefits, a fund to cover long-term care, an emergency cash fund and more.
Life Insurance Cons
There are three main negatives to using life insurance as a retirement vehicle:
Who May Want Life Insurance – and Who May Not
Life insurance should be a consideration if you have dependents who rely on you financially. In the case of your untimely death, life insurance will ensure that your loved ones are provided for. Additionally, life insurance can cover any outstanding debts as well as costs associated with your death and funeral.
If you don’t have dependents and your finances are in good order, life insurance isn’t a necessity. It’s important to note that life insurance should not be viewed as an investment. Its primary purpose is to insure against unexpected fatality, and is therefore a form of risk management. If you are looking to save for retirement or your child’s future, there are better options than life insurance.
Taking the Whole Picture Into Account
A financial adviser has a fiduciary responsibility, one that is being underscored with the implementation of the fiduciary rule, to recommend retirement options that are in your best interest. If an adviser suggests contributing more to life insurance than funding other retirement options, it may behoove you to get a second opinion. The same is true if they do not discuss life insurance at all. Additionally, make sure fees are outlined upfront in any discussion.
A good financial adviser starts with a holistic approach to your assets and future needs. The resulting financial plan should be a sound one based on your situation, not what may work for someone else.
Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.
- The first is the cost. You are paying for the underlying insurance, which you might not need down the road. Additionally, the fees can be three to four times higher than other savings options. The costs quickly add up and will eat away at your returns. Furthermore, there is a surrender value if you change your mind in the first five to 10 years, depending on the policy. After all, the salesperson got the bulk of their commission upfront on commission-based policies.
- Second, although the amount contributed for investing can vary, you must pay the premium until the policy is fully funded. But you can stop contributing to other types of retirement products, like an IRA, if you have a bad year. With a life policy, you may wind up inadvertently letting it lapse. If that happens, you lose all that you’ve contributed.
- Third, it probably will not make sense in your situation to fund the life insurance, when you have not contributed the maximum to your 401(k) or IRA. You may be better off considering more traditional retirement savings options — with your tax situation in mind — before venturing into other types.
-
Rivian Stock Gains as Georgia Plant Gets Conditional Funding: What to KnowIf Rivian's $6.6 billion government loan gets approved, it will support the construction of the EV maker's new production facility in Georgia.
-
Best Buy Stock Is Sinking After Earnings. Here's WhyBest Buy is one of the worst S&P 500 stocks Tuesday after the retailer missed quarterly earnings expectations and slashed its full-year forecast.
-
Sequence of Return Risk: How Retirees Can Protect ThemselvesYou need to understand this risk, or you might run out of money in retirement. Here's how it works — and some mitigation strategies for financial stability.
-
Earthquake Insurance: Do You Need It? What Does It Cover?Some homeowners are shocked to find out that their homeowners insurance doesn’t cover earthquake damage. Here's the lowdown on how earthquake insurance works.
-
Three Reasons Why Your Adviser Won't Talk TaxesFinancial advice and tax advice go hand in hand — or at least they should. But a lot of times, they don't. Here's why and what to watch out for.
-
Why Your Life Insurance Should Cover More Than Just DeathIf you became ill or an injury left you unable to work, how would you cover your expenses? Life insurance with living benefits could be the answer.
-
What Not to Do When Planning Your RetirementCommitting any of these four common mistakes can set you back in your golden years. Here's how to increase your chances of a successful retirement.
-
The Three Financial Questions Every Retiree Asks (or Should)Unless you can answer these three important questions, you may be at risk for the biggest retirement worry there is: Running out of money.
-
Six Missteps to Avoid as You Transition to RetirementDon't lose sight of your finances when you finally reach retirement. These six classic missteps can chip away at the nest egg you’ve worked so hard to build.
-
Why Does One Claim Jack Up My Insurance After Years of No Claims?Even loyal customers can be hit with an insurance premium hike after a claim, despite going many years without any claims. There's a reason for that.
