A more thoughtful approach to taking income from protected assets can make a massive difference in retirement outcomes for clients: it prevents the depletion of the client’s assets before death, turning a zero balance into a healthy $1.5MM portfolio.
History is full of periods of market volatility. Most recently, the extended bull market ended spectacularly in 2019, ushering in a period of volatility that makes clients nervous. This period represents an interesting buying opportunity for those still working to accumulate wealth. However, taking advantage of that opportunity can expose clients to swings in both directions, causing some to think twice before committing assets. For others, including those closer to or in retirement, volatility threatens a successful retirement.
Volatility at the wrong time can turn what appears to be an adequate rate of return into a portfolio that could be exhausted before the client’s death. Exiting the market to avoid market losses is not a viable solution, as market returns remain critical to a successful long-term retirement. Asset allocation strategies can only do so much, leaving financial instruments with some level of downside protection as a crucial element of addressing the risk of excess volatility and sequence of returns.
Individuals incorporating life insurance products into their retirement planning strategy have a powerful tool at their disposal, regardless of their stage in the journey. For those still accumulating assets, the life insurance position can provide the flexibility to stay in or enter the market with the comfort of some level of downside protection. Similarly, for those in retirement, a well-designed and funded life insurance strategy can offer the flexibility to avoid negative volatility and participate in positive fluctuations, empowering them with a different retirement outlook.
Recently, the insurance product of choice for this approach was often Indexed Universal Life insurance (IUL), offering a 0% floor and some level of upside, limited by either a cap, spread, or participation rate. While those products remain an option, they are not the only option available from the insurance segment. Today’s insurance market offers not one but three unique products that absorb or avoid some level of a market downturn while also offering some sort of positive return. They each have their unique value proposition that may make one more suitable than the others for a specific client’s risk tolerance and other elements of their retirement planning:
Clients can position some of their assets in vehicles that can avoid some or all negative volatility. However, downside-protected assets come at a cost: they limit the upside potential the vehicles offer.
What’s less clear is the impact of any of the three approaches on retirement portfolios broadly and how to consider using these products in retirement.
Table 2 shows the superior outcome for the client. By taking an equivalent, non-taxable distribution from a life insurance contract in the years following a down market, the client enjoys the same level of purchasing power and has a portfolio value that remains more than $1.5MM through age 90. This can’t be overstated in an era of elevated inflation and the spiraling cost of care later in life.
That said, two strategy elements remain open: How to fund the life insurance strategy, and which product type is the most suitable? Before addressing those questions, it is critical to understand how much additional capital would be required in the traditional investment portfolio to achieve a similar outcome. In the example used here, the client would need a starting account balance of $2,475,000 to support the desired income stream and a projected ending account balance at age 90 of $1,560,000. Evaluating the trade-offs of each approach is easier with a resource that understands the nuances of each product.
With that additional capital requirement in mind, it is then possible to project how much capital the three insurance strategy alternatives, Whole Life, Indexed UL, and Buffered VUL insurance strategies, might require to achieve the outcome shown in Table 2. ³
Whole Life Insurance: $200,000
Indexed Universal Life Insurance: $170,000
Buffered Variable Universal Life Insurance: $130,000
From a client outcome perspective, all three of the insurance solutions deliver a positive outcome:
As tempting as it is to try to identify an empirically superior solution, the reality is that the best product will vary depending on the client, their risk tolerance, and the rest of their portfolio. While three product solutions are mentioned specifically here, there are some additional nuances to consider based on the client's age at policy inception.
First, VUL insurance offers indexed or buffered strategies most appropriate for younger clients. Given that this strategy does take some time to “season” clients in their 40s, they are ideal prospects. They would have enough time to consider using traditional subaccounts at policy inception, with a subsequent transition to indexed or buffered strategies as they near retirement. Full exposure to downside risk may not be appropriate for clients who may be a bit older, making one of the downside-protected asset strategies most suitable. Clients getting a later start may need to let the insurance policy “season” a bit longer or allocate more capital to the strategy.
Regardless of how those nuances play out, the result is another powerful argument for increasing the use of insurance products in retirement planning based on their unique risk/reward profile and favorable tax treatment.
If you’d like help selecting and implementing the best insurance strategy for your client’s unique needs, connect with the team at LIFE Brokerage. We’ll guide you through product selection, policy structuring, and all the nuances to ensure the most effective retirement planning outcome.