Disclosure – I am providing general life insurance advice and definitely not investment advice. For your personal situation, please consult with your trusted financial professional.
This one gets a little insurance-y
I know that most people would prefer to chew on aluminum foil rather than read about life insurance. This post might be a tad insurance-y, but it could provide a lot of value for you, your spouse, or your heirs. Worst case – read it fast, send a link to your trusted financial professional, then go meet with them.
Once you meet with your financial professional, you can go garage sale-ing, where you might find a Dutch Brandweer (brand (fire) weer (fighter)) set!
Life insurance (almost) always has value
Don’t get rid of life insurance without looking at all alternatives. Life insurance is valuable property, pre and post-retirement.
Life insurance provides a tax favored ‘instant estate’ that can:
- protect your loved ones from the sudden loss of your income earning power (sounds better than ‘sudden death’ or even just death)
- provide a cost effective ‘guaranteed’ legacy to your heirs that could be unaffected by the vagaries of the stock market
- let you use policy loans for retirement or other purposes that may have interest rate or tax advantages.
There are a couple of different kinds of life insurance, term and permanent. Term goes for a given time (say 20 years) and is sometimes convertible into permanent. Permanent comes in a couple of flavors, whole life or universal life. Whole life is generally a simple concept: you pay level premiums for your whole life and the policy usually gains cash value over time because some interest or dividend is paid. In universal life the protection cost (cost of insurance) and cash value are separate. With universal life the cash value may grow with an interest rate that resets every year or it may be allocated to a variable subaccount (that acts a lot like a mutual fund) that then corresponds to a cash value.
I had some term policies that I converted late in their term because I decided that I might need insurance for my entire life instead of having the coverage ‘expire’ at age 65. In my case, I wanted to make sure my wife was provided for if I died ‘too early’ (isn’t it always ‘too early’?!). If we lived long enough, the insurance might be a component of a legacy to the children/grandchildren.
My need for protection is diminishing because I am nearing the end of income earning (retirement!), so we won’t need that protection anymore. The premiums of the insurance seemed relatively high (don’t they always?) and, because the policies were recent conversions, the cash value is low. I looked at how to decide what to do with them.
First. I decided that my prior premiums were ‘sunk costs’, which are costs that have been incurred and cannot be recovered. In business ‘sunk costs’ are usually excluded from future business decisions, because the future cost is not affected by the sunk cost. In our case, we paid the premiums and had the protection.
Internal rate of return (IRR)
IRR is the ‘interest rate’ that you earn on a series of payments (premiums) that pay off with a profit (or, in business sometimes a loss) in the case of life insurance, the death benefit is used in place of profit in the formula. I used the Excel internal rate of return (IRR) function to determine what the IRR would be on each policy if I lasted until various ages, up to 100.
I wanted to see if the premiums that we would pay over the next couple of decades would generate enough of a return to be a ‘better’ investment than the alternatives (stocks or bonds). For me, the IRR did not have to equal or better the stock market, because my life insurance is with highly rated firms (so less risk than the market) and life insurance proceeds are not taxed, while stock returns at death might be.
Kind of a good news/bad news thing – my IRR is great if I die soon… After examining all three policies, I found one did have a good IRR going out to age 90, one was OK, and one was poor. I will keep the good IRR policy and have planned the premiums in our retirement expense plan. We will revisit the OK policy in a couple of years and we will laps or surrender the poor IRR policy when I retire.
If you’re not familiar with IRR or Excel, ask for help (or search ‘excel irr insurance example’). I entered the premiums as costs (negative numbers) each year until my assumed ‘end of retirement’, then entered the death benefit as a positive and used that range in the IRR formula.
Because the insurance policy has a guaranteed death benefit, we will use that as the base for a legacy to the children. It is possible (likely?) that our 401(k) funds will be used up if we live long enough, but if there are some left, those could add to the legacy.
Actions you can take include:
-Review your insurance policies with your trusted financial professional. Are there term policies that might be beneficial to convert? Do you have whole/universal life policies that have features that might provide some tax favored retirement benefits?
And if you have not seen the “Why you should read this blog…WIIFY” post, it’s here.
Questions, comments, or suggestions for retirement surprise areas you want to know more about?
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