A more thoughtful approach regarding when to take income from downside-protected insurance assets can make a massive difference in your client’s retirement outcomes. In this case, it prevents the depletion of the client’s assets prior to their 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 in spectacular fashion in 2019, ushering in a period of volatility that makes clients nervous. This period can represent an interesting buying opportunity for those still working to accumulate wealth. 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. This suggests an obvious question: What’s the alternative? Exiting the market to avoid market losses is not a viable solution, as market returns remain critical to a successful retirement over the long term. Asset allocation strategies can only do so much, leaving financial instruments with some level of downside protection as a critical element of addressing the risk of excess volatility and sequence of returns. Table 1, Volatility in Retirement, shows what volatility can do to a retirement portfolio.

Table 1: Volatility in Retirement¹

However, individuals using life insurance products as part of their retirement planning strategy may have an elegant solution at their disposal regardless of where they find themselves in their retirement planning journey. Clients still accumulating assets can use their life insurance position to either stay in or enter the market with the comfort of some level of downside protection. For those in retirement, a properly designed and funded life insurance strategy can avoid negative volatility and participate in positive volatility, resulting in a very different retirement outlook.

Over the recent past, the insurance product of choice for this approach was often Indexed Universal Life (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 three unique products that absorb or avoid some level of a market downturn while also offering some 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.

• Whole Life: Guaranteed positive return each year, modest additional upside
• Indexed Universal Life: Complete protection against market risk. Market-linked upside is subject to a cap, spread, or participation rate. Account values are subject to “losses” based on policy charges in years that hit the floor
• Buffered Strategies in Variable Life: Protection for some level of market risk before client account values are impacted. Market-linked upside subject to a cap. Caps in this segment are typically higher than those in the Indexed UL segment. Like the IUL segment, account values in this category may be reduced by policy charges in years that trigger the buffer.

Clients can position some of their assets in vehicles that can avoid some or all negative volatility. There is, however, a cost to that downside protection in the form of limits on the upside potential they offer.

What’s less clear is the impact any of the three approaches may have on retirement portfolios broadly and how to think about using these products when in retirement. Table 2, The Impact of Downside Protected Assets, addresses the first question.

Table 2: The Impact of Downside Protected Assets²

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 elements of the strategy remain an open question: 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.

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 a Buffered VUL, might require to achieve the outcome shown in Table 2. ³

• Whole Life: $200,000
• Indexed UL: $170,000
• Buffered VUL: $130,000

From a client outcome perspective, all three of the insurance solutions deliver a positive outcome:

• The client’s income goal is met, including a slight increase each year to offset some level of inflation
• The client’s assets are preserved, with a projected portfolio value over $1.56MM higher than the original plan
• The insurance strategy’s lower capital requirements (as little as $130,000 versus $475,000) allow the client to enjoy more net spendable income throughout the accumulation phase than simply accumulating more assets in a traditional investment account.

However, one additional topic remains: Which of the three possible insurance solutions is the right one? 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 explicitly mentioned here, there are some additional nuances to consider based on the client’s age at policy inception.

First, a VUL that offers indexed or buffered strategies is most appropriate for a younger client. Since this strategy takes time for clients to adjust, clients in their 40s 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 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 the increased use of insurance products in retirement planning based on their unique risk/reward profile and favorable tax treatment.

¹ Assumes a $2,000,000 initial account balance and income of $110,000 per year, increasing by 1% per year.

² Assumes a 35% tax rate, male, preferred underwriting, age 45 at policy inception.

³ Policy design assumptions include a preferred male, age 45, and a twenty-pay designed for maximum accumulation.

A more thoughtful approach regarding when to take income from downside-protected insurance assets can make a massive difference in clients’ retirement outcomes. In this case, it prevents the depletion of the client’s assets prior to their death, turning a zero balance into a healthy $1.5MM portfolio.

Interested in learning more? Let’s chat!

#LifeInsurance #RetirementPlanning #SequenceOfReturns #TaxDrag

Subject Line: Market Volatility: A Challenge or an Opportunity?

History is full of periods of market volatility. Most recently, the extended bull market ended in spectacular fashion in 2019, ushering in a period of volatility that makes clients nervous. For those still working to accumulate wealth, this period can be argued to represent an interesting buying opportunity. 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. This suggests an obvious question: What’s the alternative? Exiting the market in an attempt to avoid market losses is not a viable solution, as market returns remain critical to a successful retirement over the long term. Asset allocation strategies can only do so much, leaving financial instruments with some level of downside protection as a critical element of addressing the risk of excess volatility and sequence of returns.

If you want to look at how we’re designing this strategy with other advisors, contact me to learn more today.