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Filed Under:Markets, Senior Market

How to Use Whole Life Insurance as Your Client's Retirement Savings Plan

It may seem logical to support any savings program that rewards its participants by allowing them to not pay current taxes on the amounts they annually contribute to a retirement plan.

On closer examination, however, would this program appeal to the public if it were explained like this: "There is a special government-backed retirement savings plan that allows you to not pay taxes now on your current contributions, lets you accumulate growth on the contribution and on the accumulating earnings tax-deferred -- and then requires that you pay four times as much income tax when you withdraw the money or if you die"? How many plan contributors would buy this financial logic?

If we had comparative examples of ways to mitigate taxes altogether and obtain equal or better distribution results from the accumulation of the same assets while protecting those assets for the next generation, income tax-free, do you think that kind of alternative possibility would draw curiosity?

Let's go even further: How many people who participate in retirement programs through their employer have even been given a choice of how to save their money? Is there a better way?

The setup
Whether you are an owner-employee or just an employee, you are allowed to contribute to a retirement savings account at a certain percentage based on your income, age, or both. This example applies to an owner-employee of a fictitious plumbing company.

Based on retirement planning contribution law, let's assume the owner is allowed to contribute $50,000 a year to their retirement plan. If the owner took this money as income today, they would pay $14,000 annually in income taxes, assuming the owner was in a 28 percent bracket.

But if the owner instead contributed that annual $50,000 to a retirement plan through their business for 25 years, they would have contributed $1.25 million and would have received a $350,000 tax deduction, which reflects the owner's tax bracket and the taxes not paid on the amount contributed to the retirement plan.

Scenario 1: A tax-deferred retirement savings plan
Let's assume the retirement contribution of $1.25 million dollars grew at a compounded annual rate of 6 percent, accumulating $2.74 million in cash assets by age 65. If the owner needed $165,000 for living expenses at retirement or 6 percent of the account value starting at age 66 and the account was converted to a non-risk portfolio earning 4 percent per year, how long would the distributions last?

This is a very real scenario that happens every day when someone trades a business paycheck today for a personal paycheck from their retirement account later on.

Our owner's 28 percent tax bracket requires a withdrawal of $230,000 per year in order to net out $165,000 per year, translating to $65,000 in annual taxes. Given this, the owner's income stream would last 17 years and taxes paid would amount to $1.1 million. The $1.1 million tax bite eroded the retirement fund and more than tripled the tax the owner would have owed had they instead paid the tax annually on $50,000 of income and then invested the difference in a tax-deferred account.

Is the consumer better off accumulating in a tax-free environment than in a tax-deductible and deferred retirement plan?

Scenario 2: Whole life for retirement
Now, there is an interesting alternative to Roth IRA-type planning that advanced-planning insurance advisors are using -- they are using a Roth-style funding approach, using whole life insurance to implement a retirement strategy.

Why whole life? Because the compounding effect of the inside buildup of cash (which is guaranteed), coupled with non-guaranteed dividend distributions, allows investors to dramatically prolong income distribution.

The problem with traditional government-approved Roth IRAs is the cap imposed on the contributions and the parameters of earning for husband and wife. Roth 401(k)s expand the investor's ability to fund their retirement at the same levels as traditional 401(k) plans -- a good start toward increasing the contribution limits. But whole life insurance lifts the challenge of contribution limits ($5,000 per year; $6,000 if you are older than 50) and income restrictions (if you are married and earn more than $160,000, you cannot participate) imposed by the government.

When we compare the results, we see why using whole life has more advantages: It is easy to understand, and it creates a dramatic paradigm shift of possibilities.

If we join the analysis of the $50,000-per-year pension contribution with the results of a study that we conducted with four whole life insurance companies, rated AA+ or better, we can compare the data to see how long income will last and how much of a benefit whole life insurance imparts.

Here, we asked for illustrations on a 40-year-old male contributing $50,000 per year for 25 years. This contribution produced a life insurance benefit of between $1.4 million and $1.6 million, depending on the company. In year 25, the cash accumulated inside of these policies averaged between $2.25 million and $2.3 million. Remember that in the pension account, we assumed a $50,000 annual contribution that grew at 6 percent compounded annually, and we know this would accumulate to $2.74 million -- $500,000 more than the inside buildup of the whole life policy.

However, we also looked at the results of a $165,000 annual distribution. The insurance policies were able to fund $165,000 for 20 years, and when the client died at age 100, beneficiaries received an additional $750,000 in death benefits.

(Each policy is different, and this example shows the results from one particular company). In all, the whole life policy produced $3.3 million worth of tax-free income and $4.05 million of income tax-free total benefits. The pension produced a little more than $2.8 million in income, was only able to fund $165,000 for 17 years, and resulted in $1.1 million in taxes. In year 18, the pension ran out of money with the last five-figure distribution.

The difference in paying taxes versus not paying taxes makes a dramatic difference; when paying taxes, the account that contains more money simply runs out sooner.

The life insurance edge
The federal deficit is soaring and taxes are going up -- there is no question about that. Because of this reality, it is essential to plan in the tax-free zone for high-income earners and for those who would be interested in Roth 401(k)-style growth.

Although past performance is no guarantee of future results, you can quantify the healthy gains in whole life insurance in this last decade when compared with the 10-year investment results of risk-oriented investment benchmarks, and although interest rates were at their lowest sustained levels during this period, the performance of whole life insurance stood ground with -- and outpaced -- many money market funds, CDs and mutual fund portfolios. The results will cause any planner with a fiduciary responsibility to give pause.

When considering a conservative and guaranteed investment portfolio with the goals of income and long-term wealth creation, producers must do a comparative study using whole life insurance against the benchmarks of outside investments.

Barry Goldwater is the principal of Financial Resource Group. He can be reached at

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