A friend of mine asked how positioning high cash value whole life insurance as a tier one asset would be beneficial to a younger person planning to retire from W2 work at an early age.
Cash flow is the gasoline that fuels your businesses and your personal economy, and it’s one of the most important principles of financial strategy. What good does a big pile of money sitting in an account do if you don’t turn it into cash flow at some point?
Even those who prefer to accumulate wealth inside of typical financial vehicles such as 401k’s, IRA’s, and non-qualified investment accounts will eventually need to figure out how to sustainably withdraw the cash in order to fuel the passive income years.
Typical financial planning advice recommends a portfolio withdrawal rate of about 3.5% to 4%. That means if you have a portfolio of one million dollars, your annual income from that would be $35,000 to $40,000.
Many people don’t think about the need to have one or many streams of cash flow in retirement when they are young and just starting to save and invest. They are not beginning with the end in mind.
How can we implement a strategy to increase the distribution rate of an accumulated portfolio beyond the recommended 3.5% to 4%? One way is to utilize a single premium immediate annuity (SPIA) in conjunction with an equivalent amount of whole life insurance death benefit.
It works like this.
A 40 year old male with an expected $1 million portfolio at retirement would purchase whole life insurance in the years leading up to retirement equaling $1 million in death benefit. He would structure the policy so that no further premiums would be due once retired.
Then, at retirement, let’s say age 70, he would use the $1 million that had been accumulated in investments to purchase a SPIA. In today’s low interest rate environment, the payout would likely be around 6%, or approximately $60,000 per year. That is a more than 70% greater distribution rate than if this person used the 3.5% to 4% rate typically recommended.
The $60,000 per year would be payable every year until death. If this person lived to age 100, that would be $1.8 million paid out.
The reason the payout rate is so much higher has to do with actuarial science. The insurance company knows that a certain percentage of annuity purchasers will die prior to being paid out the full amount. What if our hypothetical client is one of those folks and dies prior to having the full $1 million paid out?
That doesn’t sound good, you say. Agreed.
Because this person secured $1 million of life insurance though, his estate or beneficiaries would receive $1 million, no matter how much had been paid out via the annuity.
Additionally, the SPIA could be structured to offer a refund of any premium not paid out prior to death. However, this would decrease the annual payout rate, which is why having the life insurance death benefit in place is so beneficial.
By starting young and beginning with the end in mind, this person was able to enjoy a significantly better quality of life in retirement with a much higher distribution rate from his portfolio than the person following typical financial advice.
Just as important is the fact that the cash value inside the whole life insurance policy is available to leverage for other opportunities all along the way.
In this case, that’s 30 years of access to a growing pool of capital for whatever life throws at you. Now, that’s peace of mind.
As always, contact us with any specific questions or ideas concerning the use of your policy, or if you are interested in learning more about adding a specially designed policy to your tier one assets.
Thanks, and please share this with anyone you think would find it valuable.