Saving as much money as possible in a tax-deferred account is the standard way to prepare for retirement. But that might not be enough.
Rick Kahler, the founder of Kahler Financial Group, in Rapid City, S.D., tells us how to use insurance to keep the dream alive.
Larry Light: So you can use life insurance to fund retirement?
Rick Kahler: Some of the typical reasons for life insurance are to replace a breadwinner’s salary, pay off large debts, and pay estate taxes. Another reason to carry life insurance—if it’s the right kind—can be to fund a retirement plan.
To illustrate, let’s imagine a couple, both 55, with two grown children, two good jobs and no debts. They began funding their retirement only recently. Leigh’s entire salary of $124,000 a year goes into company retirement plan options: $64,000 into the 401(k) and profit sharing plan and $60,000 into the cash balance plan. The couple lives on Mischa’s salary of $60,000 a year.
Their financial planner has calculated that in 10 years they will have a good chance of having $1.5 million saved in retirement plans. This amount will allow both of them to retire, continue to live on $60,000 a year for the rest of their lives, and have enough to fund long-term care for one of them or leave a nice inheritance to their kids.
Light: What about the threat of a job loss?
Kahler: The death, disability or loss of a job of either of them is not a threat to their current lifestyle. However, it is a threat to their retirement plan. And the loss of Leigh’s job is the biggest threat. While finding a new job that would allow retirement plan contributions to resume is possible, it is not guaranteed.
Nothing can be done to insure against the loss of a job, but there are ways insurance could help protect this couple. They could purchase disability insurance to replace 60% of the income of either partner. This would allow them to still make a reduced contribution to their retirement plan.
Light: What about of one of them dies?
Kahler: If either of them should die prematurely, especially Leigh, it’s doubtful Mischa could cut expenses enough to put anything significant toward retirement. Instead he’d have to work as long as possible and then rely heavily on Social Security.
This a where a 10-year term life insurance policy on Leigh would make a significant difference. If they purchased a $1 million term policy on Leigh now, the premium (for a nonsmoker in good health) would be around $1,200 annually. Should Leigh die this year, if Mischa invested the insurance payment, it would have a high probability of growing to $1.5 million in 10 years. This would allow Mischa to retire comfortably.
However, the older Leigh and Mischa get, the less they need the insurance. If Leigh died in the fifth year of the policy, the five years of savings plus the insurance proceeds would accrue more than $2 million over the following five years.
Light: Is there a more cost-effective alternative?
Kahler: One cost-saving strategy would be to buy two $500,000 10-year term policies and drop one after five years. This would still provide for a total of around $1.5 million in retirement funds for Mischa by age 65 if Leigh should die before that time.
Light: What about a cash value plan?
Kahler: Yes, a life insurance agent might suggest putting Leigh’s salary into a cash value policy instead of buying term. Let’s look at that.
Contributing $124,000 into the retirement plan saves $24,000 a year in income taxes, so only $100,000 a year would be available to buy insurance. This amount would cover a policy with a $1.9 million death benefit and a cash value guaranteed to grow to $1,036,328 in 10 years.
Given the extra tax payments, plus premium costs of $1 million over 10 years, that’s not a good investment for our couple. The commission of $72,500 makes it a great investment for the salesperson, though.
Besides, in this circumstance, life insurance is not meant as an investment. It is an affordable way to replace the income that covers Leigh’s retirement contribution
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