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  • Writer's pictureDavid H. Kinder, RFC®, ChFC®, CLU®

F.A.Q. #11 - What Is the Capital Equivalent Value of Life Insurance in Retirement?

Updated: Jan 18, 2023

Well, that's a long title! But the question remains: What is the equivalent value of life insurance to most traditional retirement income planning?

First, let's talk about the "elephant in the room": The rates of return on all cash value policies will NOT out-pace investment equivalents. However, from a TAX perspective, life insurance is FAR more efficient.

So, let me ask you this question:

Which would you rather have?

a) $5,000,000

b) $3,000,000

Now, most people would say that they want the bigger number - the $5 million.

However, that's not the whole story.

What if:

a) $5,000,000 and you took out 2.8% a year or $140,000 FULLY TAXABLE (and for a 90% chance of NOT running out of money)!

b) $3,000,000 and you took out $140,000 a year 100% TAX-EXEMPT! (You could actually get more, but I wanted to keep the numbers equal.)

Now, which person would you rather be?

Let's figure out the math of the taxes on Person A:

  • Federal Income Taxes: $140,000 + 85% of your Social Security Benefits (assuming $60,000 for joint spouses) would bring your reported taxable income to over $200,000. According to 2019 taxes (with standard deduction, etc.) you would be in the 24% tax bracket with a tax liability of $36,349

  • State Income Taxes: You would be in a 6.16% state tax bracket for a cost of $12,090.

  • Social Security Income Taxes: When your income is above $45,000 from other sources, 85% of your Social Security becomes included in the taxable income formula. Assuming 24% x $60,000 = $14,400.00.

  • Medicare IRMAA Taxes: Based on this amount of income your Medicare Part B premiums increase to $428.60 per month or $5,143 per year.

  • Investment Management Fees: 2% on average for the entire plan balance. That's not just the investment advisor's fee, but 3rd party asset management, platform, and custodian fees all included.

So, with all of that… that's why you'd need $5,000,000 in order to generate 2.8% distributions of $140,000.

By the way, did you happen to notice that YOU get paid 6TH in this line of people waiting for their money FIRST??

But what if you could avoid ALL of that?

  • No Federal Income Taxes?

  • No State Income Taxes?

  • No Social Security Income Taxes?

  • No Medicare IRMAA Taxes?

  • No Investment Management Fees?

What if YOU got paid first out of your assets instead?

And if that's the case… what would be the Equivalent Rate of Return difference between these two strategies?

  • To spend $3 million TAX-FREE spending $140,000 a year as though it was $5 million in a 24% tax bracket

  • A difference of $60,000 a year, each year for 10 years = $600,000 / $5,000,000 = 12% per year WITHOUT stock market risk!

And if you were in an even HIGHER tax bracket (such as the 37% bracket)… it would be an even HIGHER taxable equivalent rate of return! I've seen it as high as 27.58%!!!

Let's look at those Financial Expenses above:

  • What if, we could either eliminate those investment fees OR get real value in exchange for those fees?

  • What if, you didn't have term insurance (that would typically expire before you would) and you had a permanent policy instead?

  • What if, you could borrow from yourself and have unstructured repayment terms without needing IRS 'hardship provisions', taxes, or penalties?

  • What if, you could use your money AND have it still work for you as though you never touched it?

Proper life insurance planning can help you to greatly reduce or eliminate these "holes in the financial bucket" and really gain ground!

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