Retirement Income Strategies
So, how much does it take to retire? Well, it depends…
It depends on many variables, and that’s exactly why people get confused. In this post I’ll try to shed some light on how to spend your assets for distribution during retirement, the most efficient way.
Capital Equivalent Value
This post is partially based on the retirement income strategy found in the book, The Capital Equivalent Value of Life Insurance by Bryan Bloom, CPA.
Capital Equivalent Value, as defined by Bryan Bloom, CPA in the book Confessions of a CPA, is the sum of money a financial asset would have to grow to in order to provide the same benefit of another financial asset (like a permanent life insurance policy). In other words, it’s a comparison when considering income options for retirement.
How Much Does It Take To Retire? The Bottom Line is Cash-Flow
Like most things in life, when contemplating retirement income, you have to start with the end in mind. And, that means we have to focus on the amount of spendable income or cash flow we will have to live on until mortality.
Business owners look at operating cash-flow, and understand they still have expenses. This is important because we’re talking about an asset that will operate like a business.
“When you buy a life insurance policy you are starting a business.”
~Nelson Nash
Distribution Rate vs Rate of Return
The rate of return is not the amount you can retire on. You can’t spend the rate of return.
You have to calculate a value before you can determine distribute income. The sum of money you have to distribute over retirement is a primary factor, but there is more you should know.
In order to calculate this amount of capital, you have to consider the accumulation rate, and this is much different that the distribution rate.
Using Monte Carlo simulations the typical retiree can utilize a 4% distribution rate with a balanced portfolio for income. This strategy however, may only work 90% of the time, so there is a 10% chance of failure.
Maybe it’s time to consider another perspective on rates.
Paying Taxes for Life?
When you reach retirement age, and perhaps 40 years of paying income taxes, do you think you will feel that you have you paid enough taxes already?
Sadly most people will pay taxes for their entire life… and many after they’re gone.
The good news is, there is a better way! A few assets provide provide tax free distributions. Let’s explore some options.
Municipal bonds can be tax-free, but they are coded as provisional income, therefore bondholders can be penalized by having to pay taxes on their Social Security income and possibly higher Medicare premiums.
ROTH accounts allow for tax-free distribution, but there are lots of limitations during the accumulation phase of saving for retirement. During distribution they may also trigger higher Medicare costs.
Tax exempt means it is not reportable as income to the IRS, and does not count in your provisional income. Most assets require reporting during retirement on income tax returns in the form of a 1099-R (tattle tale form).
Life Insurance Retirement Plan
Permanent life insurance offers many options at retirement, including tax-free distributions when supplementing other income. But, a little known retirement income strategy allows for tax-exempt cash flow, therefore it is not reportable as income for tax purposes.
When discussing life insurance the inclination is to compare it to other retirement plans, and that’s understandable, but it’s a difficult comparison.
Most people buy life insurance as death insurance. Typically this is term insurance, and it’s not really for your benefit, it’s for your loved ones when you die. Unfortunately, it’s rare that these types of policies ever pay a death benefit.
Wealthy families understand something about wealth transfers And they know that eventually everyone will die. So, permanent life insurance can provide living benefits, reduce or eliminate wealth transfers, and ultimately pass on tax free wealth to the heirs.
Life insurance stands alone when comparing it to other assets because it can perform multiple tasks using the same dollars. In this case, we’re talking about planning for retirement income, so we’ll focus on the distribution aspect.
All other assets provide singular functions, and while some hold the opportunity for greater returns, they also have greater risks. These risks range from the risk of financial loss, to tax risks to longevity risks.
And, since most people will have another source of income at retirement, life insurance is a financial solution to safeguard their retirement plan. For example, a volatility buffer against market risks during distribution.
Of course not everyone is eligible for life insurance, but should someone choose to utilize a standalone life insurance retirement plan, it can outperform others when it comes to distributing income.
Financing Your Retirement
Uninterrupted Compound Interest allows you to use borrowed proceeds from a life insurance contract. Of course you could borrow money in any number of ways, but who’s going to loan you money after you’re retired?
Guess what banks want when they loan us money? Collateral. And, what collateral do banks like that works best during retirement? Cash Value Life Insurance.
The death benefit is the collateral when using life insurance for financing. You can borrow against your collateral capacity, or your net cash-value in the life insurance contract.
The Life Insurance Retirement Plan allows for flexibility and uninterrupted compounding of the account. So, even after a loan is taken, the account continues to grow. This is because the policy serves as collateral, and the loan is from the insurance company.
Simple Math
Math is not money, and money is not math. So, calculating the distribution from a qualified retirement plan can get really complicated. You can check out the math here in this 401k Calculation.
For simplicity, in this example we are going to compare different accounts when distributing income at retirement. The image below is comparing traditional retirement plans to whole life insurance for net income or positive cash-flow.
So… How Much Does it Take to Retire?
Retirement is relative, meaning everyone’s situation is different. The above comparison shows distributions from an account with a $1,000,000 balance.
The entire point of this post is to give you a comparison of how much you can spend from a retirement account. A better question might be, do you want to have a similar lifestyle during retirement as you have today?
Perhaps you’ll need less, or perhaps you’ll want more to travel and do things for your family and causes. What we all should consider is, the most efficient way to create wealth and spend it without the fear of running out of money.
Numerous retirement studies have been done to find the optimum way to distribute income. The most popular one being the 4% rule for distributing assets, but even this rule has been challenged in recent years because of the low interest rate environment.
Life Insurance During Retirement
Life insurance distributions can be taken in many ways, and certain distributions could be taxable. By taking money out in the form of a loan it is tax exempt.
If a whole life insurance policy from a mutual life insurance company has been properly funded for 10 years or more, it should provide cash-flow in the form of loans at approximately a 6% distribution rate. This can vary based on many factors including age, policy rating, the carrier and the type of policy.
Should the policyholder die with a loan outstanding, the life insurance company will subtract any outstanding loans and unpaid interest from the death benefit.
Death benefit proceeds are generally tax free to the beneficiaries as long as the overall estate does not exceed the current taxable limits.
Perhaps the biggest benefit of a properly structured life insurance retirement plan is control. These plans are flexible and can provide many benefits to the policyholder.
When considering income for retirement, compare your options, you may find that traditional retirement plans just don’t pass the income test. A close inspection of your current finances will help you determine how much it will take for you to retire comfortably.
If I can help, just let me know by leaving a comment or scheduling a review.
Until next time,
Barry Page
Barry Page is recognized as a leading expert on finance and life insurance. He is a an independent life insurance agent who helps clients with alternatives to traditional banking and investing.