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AS I PLAN MY retirement, I have the advantage of a strong background in finance. I worked for 35 years in the investment field, primarily managing mutual funds. Early on, I obtained the Chartered Financial Analyst designation, which helped immensely.
Six years ago, when I was age 55, I embarked on a journey to comprehend the myriad rules and strategies surrounding retirement. I studied to become an RICP—a Retirement Income Certified Professional. While the CFA was useful for investment management, the RICP helped me understand how investments fit with insurance products.
From the RICP program, I learned about the 4% rule and planning for a 30-year retirement. But the 4% rule only concerns financial assets. It doesn’t address other income sources, notably Social Security and annuities. I also learned about the “retirement smile,” a term coined by David Blanchett, who analyzed retirees’ spending through retirement. His finding: Retirees’ spending declines steadily in retirement until the later years, when long-term care (LTC) expenses tend to rise.
Another major issue: How will your retirement income be taxed? Retirement account withdrawals are taxed at ordinary income tax rates. Regular taxable accounts currently benefit from a favorable capital gains tax rate. Roth, health savings accounts and cash-value life insurance all offer tax-free withdrawals—if done correctly.
Since the traditional IRA continues to lose its tax advantages relative to other accounts—the stretch IRA has been slashed to 10 years and account holders are forced to take required minimum distributions starting at age 72—I’ve been looking to shrink my traditional IRA.
To that end, I used my IRA to purchase three different deferred income annuities, formally known as QLACs, or qualified longevity annuity contracts. Those will pay me income starting at ages 76, 80 and 85. I also purchased a “period certain” annuity, which will pay me income from age 62 to 69. That will give me extra income until I start Social Security at age 70. In addition, I’ve been converting part of my IRA to a Roth IRA each year, paying taxes along the way.
These various steps will increase my guaranteed income, allow me to delay Social Security and create a tax-free pool of assets. Did I mention that I obtained an insurance license, so I earned commissions on the annuities that I purchased for myself? Still, even if I hadn’t collected those commissions, I would have bought the various annuities.
At age 55, I also purchased a whole-life insurance policy. As an investment manager, I had always bought term insurance, because I knew I didn’t understand whole-life policies. The two major drawbacks to whole-life insurance are the large commissions paid to insurance agents and the large premiums relative to the death benefit. I wrote the policy on myself, so I earned the commission.
Meanwhile, I wasn’t buying the whole-life policy for the death benefit per se, but rather to accumulate tax-free assets, while also investing in a fixed-income investment that wouldn’t decline in value if interest rates rose. This will be my safe haven fixed-income bucket—and it’s potentially tax-free, to boot.
Owning the whole-life policy freed me up to buy the income annuities. How so? When I die, the annuities cease paying income, but the tax-free death benefit from my whole-life policy will be there for my kids instead. I had hoped to be able to get an “LTC rider” on the life insurance policy, but the insurance company turned me down. That lead me to another insurance product.
I attended a presentation explaining hybrid LTC insurance. I had studied the product while obtaining the RICP, but I wasn’t especially excited about it. But as I researched the product further, it seemed like it solved a host of problems. Since I was declined for the LTC rider on my life insurance, maybe I could qualify for this. I did.
The only thing I knew about traditional standalone LTC insurance was that premiums were never guaranteed and, indeed, the policies have seen dramatic premium increases. By contrast, hybrid LTC policies can’t increase premiums. Owning a policy that would offset costs at the far end of the “retirement smile” meant I didn’t have to worry about rising expenses, should I need long-term care.
On top of that, I now count my hybrid LTC policy as an asset, since I can get a full refund at any time and, if I never need LTC, the death benefit is double what I paid for the policy. One other step I’ve taken: I continue to fund an HSA, or health savings account, since I have a qualifying high-deductible health plan.
I’ve found it helpful to use a spreadsheet to project my retirement income. Each year, different streams of income become available. At age 60, my pension began, which covers my mortgage and my health insurance premiums. At age 62, my “period certain” annuity begins, and that will supplement my pension until age 70. This guaranteed income reduces the need for income from my investment portfolio.
At age 70, my period certain annuity stops paying and I plan to start Social Security. Also starting at age 70, I might withdraw from my Roth account over the next five years if I need additional income. At age 75, I plan to withdraw tax-free income from my cash-value life insurance—but again, only if it’s needed. The withdrawals will be tax-free provided I don’t take out more than the total premiums I’ve paid.
As I hit ages 76, 80 and 85, I’ll have additional lifetime income, as the three QLACs start paying. By age 85, I should have sufficient income from the QLACs, Social Security and my pension to cover most of my living expenses. If I need to pay for long-term care, my hybrid LTC policy is available. My brokerage account and Roth account will also be there as backups. Finally, there will be a death benefit from the life insurance as a legacy.
I believe in diversification in retirement planning, just as I do in investments. I know many money managers look askance at insurance products. But I now understand why insurance agents like the guarantees and security of their products. Like my LTC insurance, I find I’ve become something of a hybrid myself. Most of my assets remain invested in the stock market. But I now also have annuities, life insurance and a hybrid LTC policy on my balance sheet—and they’re there for tax reasons, as a hedge against a surprisingly long retirement and as way to pay for the long-tailed risk of needing long-term care.
James McGlynn, CFA, RICP, is chief executive of Next Quarter Century LLC in Fort Worth, Texas, a firm focused on helping clients make smarter decisions about long-term-care insurance, Social Security and other retirement planning issues. He was a mutual fund manager for 30 years. James is the author of Retirement Planning Tips for Baby Boomers. His previous articles include Early Decision, Your 10-Year Reward and Four Simple Tips.
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What strategy have you employed for survivor income (or would suggest if not applicable to you)? You seem to have bet on your own longevity, but what income stream(s) would continue if you don’t make it past 70 for example.
The tax free death benefit from life insurance and the higher survivor benefit from Social Security help there. I also don’t plan to spend down my Roth or brokerage account unless necessary and they will be tax advantaged versus the IRA.
James, excellent article. I also took the RICP, and now looking at similar thoughts. You solved one of my major problems/concerns – my lack of knowledge/experience with insurance products. I’m looking at a ~6 year gap between retirement and social security at 70. I have a pension which will cover a good part of our expenses, but still thinking about how to fill the difference. Do you have any suggestions for those of us inexperienced in insurance products on where to start, and how to evaluate products? I’ve tried to model some the more complex life insurance with guaranteed lifetime income products, but it is hard to get the info, and to figure out the return. Thanks.
Thanks to Wade Pfau for promoting the concept of setting aside cash or something safe for the gap. Ideally layering CD’s was a thought but too much work and now yields too low. Since I needed to fill age 62-69 I invested a lump sum in a period certain annuity to pay me monthly. Can get a ballpark estimate at http://www.immediateannuities.com. My whole life policy is a lot more complicated and might be the subject of another article. Can email me with other questions.
Which part of the insurance can’t you see?
I think one needs to keep in mind that there is no such thing as a free lunch. The “advantages” of whole life insurance over term life insurance and hybrid LTC policies over traditional LTC policies no doubt reflect their higher costs.
Years ago I used to watch a great chef on TV, Martin Yan, debone an entire chicken in less than 20 seconds (mostly looking up at the camera). It was very entertaining but I knew that if any “normal person” tried it, he or she would end up losing a finger. I have the same feeling after reading this.
I didn’t say it was simple. I agree if we all had great pensions we wouldn’t be going through these contortions.
James has gone way too far down the LI products rabbit hole here. LI companies take about half your premium for themselves, and invest the rest in the same stocks and bonds you could buy directly. Stick with real assets.
The LI provides my tax free fixed income piece. Hard to replicate that in this low interest rate environment. I am not a fan of LI for investment returns but for the stable part of the portfolio. You are correct that the LI companies are highly profitable and that is how my cash value can increase even with low rates. (I know this is the most controversial piece of my plan as so many people bought and canceled policies and lost their premiums.)
That’s an interesting approach and I have planned a strategy using certain insurance products as well. My wife and I purchased group long term care from my employer in our late 40’s and fortunately the pricing hasn’t changed yet, approximately 10 years later. I have also read up some on Wade Pfau and hope to purchase some immediate annuities similar to Jonathan’s plan he laid out in recent columns. Last, I took out a guaranteed Universal Life policy at age 50 (I think of it as a permanent term policy not designed for cash value accumulation). The intent of the policy is to backstop a benefit for my heirs to replace the funds used to purchase immediate annuities. I think using immediate annuities for a portion of one’s bond allocation makes complete sense due to the mortality credits and longevity insurance provided.
I see no mention of inflation. Many (myself included) see inflation as a major risk to retirement planning. Apologies if I am missing something, but I do not see where your plan accounts for this.