Life insurance policies have long been heralded as “the great financial Swiss Army knife” in financial planning (by those who know how to use them). The danger lies in getting ONE policy to do too many things.

For example, there is a concept called “The Retirement Spend Down”. Most retirees don’t want to spend down their principal balances in accounts and end up living a “just in case” retirement. “Just in case” interest rates rise, the stock market crashes, or even for when they die – they need to leave money to their spouse to live on. (Much of that has to do with the notion that we don’t want to see that account balance go down either.) What ends up happening, is that retirees end up preserving their assets for their children and grand children... and THEY end up spending it all and enjoying it, rather than you!

The notion of “permission slip spending”

Which income options would give you a higher cash flow in retirement?

• Pension:

• a) take the joint life and survivor option

• b) take the life-only option

• 401(k) and IRAs:

• a) Take out interest only

• b) Take out principal & interest

• House:

• a) Live there

• b) Live there and take income

• Other appreciating assets such as business interests, rental property, stocks, etc.

• a) Take only interest & dividends

• b) Take principal, interest & dividends

In each of these instances, choosing “b” would give you the higher retirement income.

So, what’s the problem? The problem is: Would our surviving spouse still be financially okay when we die? For example, with the pension, if you take the ‘life only’ option… when you die, that income stops. With everything else, there would simply be less there, or that asset could be exhausted.

Note: We didn’t even talk about Social Security. With Social Security, you both may have a retirement income benefit, but once one spouse dies, the surviving spouse gets the larger of the two benefits, but not both.

With sufficient life insurance in place, the death benefit can replace these lost values! That’s the idea behind “Pension Maximization” where you can take the “life only” pension payout, but you use a portion of it to purchase some life insurance to help replace that value when you pass away. But you don’t have to limit it the concept to just your pension, but other assets that you can leverage or spend down.

My concerns:

While I DO like this notion, and it makes economic sense, there’s often not enough detailed analysis when marketing this strategy to the public to inspire their confidence in doing it. Plus, it often “sounds” like these agents and advisors are recommending that you can use one policy to “do it all”.

In an earlier blog post (Titled “Permanent Life Insurance Myth #1 Debunked: "The Life Insurance Company Keeps My Cash Values When I Die"), I discuss the formula to calculate net death benefits.

Net death benefits = cash values + net amount at risk – any outstanding loans

If you have an “investment grade”, “maximum funded” life insurance policy that you plan to take out loans against for tax-free retirement cash flow… then the part you can safely do “spend down” strategies with is the net amount at risk and not necessarily the projected net death benefits. And if this policy truly is “maximum funded”… then that amount may not be as leveraged for the premium dollars as it should be.

Investment Grade Policies vs Minimally Funded Policies

They are on the exact opposite sides of the fulcrum.

• Minimum Funding secures Maximum Death Benefit Protection

• Maximum Funding secures Minimum Death Benefits to Maximize Cash Value Asset, Income Tax, and Leveraging Advantages

Why can’t I use the same policy for ‘permission slip spend down’? If, and when, you begin to access the cash values, every loan will need to be repaid from the total death benefit. This means that you probably should not rely on the same policy for retirement income as you can for “permission slip spending”… at least not without detailed ongoing analysis.

Could you use the same policy?

I suppose you can… but there are a few “if’s” in doing this with the same policy. And the more times you say “if”… the less guarantees you have in making a strategy (or product) work.

If:

• You can determine what loan interest will be on your cumulative outstanding loans. Cumulative loan interest means more performance is needed on your cash values and the more it will “eat away” at your ‘net amount at risk’ – eroding the power behind this concept.

• You can accurately determine your policy performance to help offset life insurance loan interest costs.

• You can determine how much ‘pure insurance’ you’d still have left at your life expectancy.

There Is A Far Better Alternative

I don’t like having to use the word “if” when talking about financial strategies. And the more you try to get one policy to do multiple things… sometimes, you try to make it do too much.

If you want to do a retirement income spend-down, I would obtain either a 1st to die or 2nd to die life insurance policy (depending on your goals and whom you want to ultimately benefit from this policy) – ideally a guaranteed non-lapse universal life policy.

Guaranteed non-lapse universal life policies are not designed to build up cash values. They are the least expensive way to guarantee a given death benefit through a given age, such as age 90, 95, or 100… and it is priced accordingly for the desired time frame you want the protection.

As long as premiums are paid every year, your policy is guaranteed to remain in force.

The best way to pay for it is out of the assets or returns of your other assets, rather than out of other cash flow.

Bonus: They may also have chronic illness riders that may be accessible for long term care expenses.

If possible, use one policy for its cash values and other characteristics, and use another policy for its pure death benefits.

Of course, you still have to medically qualify for this coverage. I would suggest that obtaining such coverage for this purpose when you’re age 55 to 65 or so would probably be the best way to go… but I’m saying that as a general rule. For more information on this concept, here is an article from CPA Wealth Provider magazine in 2007 discussing the "permission slip" concept.

And here is another report in a narrative story form also outlining this concept: Permission To Spend White Paper