MANY FOLKS ARE do-it-yourselfers when it comes to home improvement projects. On that score, I have no skills, so I end up paying others. In fact, in high school, I was so anxious to avoid metal shop and woodshop that I opted for typing and four semesters of bookkeeping.
It’s a different story when it comes to my finances. Yes, I use an accountant to file my taxes. But helped by both a degree in finance and the Chartered Financial Analyst designation, I handle other money issues myself. Indeed, during my career, I kept my money in the mutual funds I managed, rather than paying someone else to handle my investments.
I left the investment field six years ago, at age 55, and began my retirement planning journey. To understand my choices better, I earned a Retirement Income Certified Professional designation, as well as obtaining life and health insurance licenses. I came to realize that—as a retiree—I needed to protect myself against four major risks: tax increases, a surprisingly long life, rising interest rates and potentially huge long-term-care expenses.
1. Tax increases. During my high-income years, I funded a 401(k) plan, which meant I deferred taxes on the income involved. Now, with my income lower, I have the chance to “undefer” this income.
When I left my investment job six years ago, I rolled my 401(k) into an IRA. Each year since, I’ve converted part of that IRA to a Roth IRA, where the money now grows tax-free. In effect, I’ve prepaid a big chunk of my retirement tax bill and protected that money against future tax increases.
I strongly suspect those tax increases are on their way. The federal government has spent massive sums to soften the pandemic’s financial blow. The huge taxable amounts in tax-deferred IRAs will, I believe, be a prime target. I also suspect that today’s low capital gains rates will come under attack. Both Social Security and Medicare already penalize recipients who have a high taxable income, and there may be more of that to come. On top of that, tax rates are scheduled to increase in 2026, when many provisions in 2017’s tax law sunset.
2. Living long. Even with the Roth conversions, I was left with a substantial sum in my traditional, tax-deferred IRA. I decided to use some of that money to fund two accounts that’ll boost my guaranteed lifetime income, thus hedging the risk that I live far longer than average.
Even though neither of my parents lived to their 80s, I’m banking on a long retirement. My hope: By exercising, eating healthily and not smoking, I’ll live longer than average, plus the data show that those with higher incomes are more likely to live to a ripe old age.
I was intrigued by the concept of longevity insurance, particularly so-called QLACs, or Qualified Longevity Annuity Contracts. A QLAC can be funded using IRA money, with the annuity’s payment start date set as late as age 85. You can use up to 25% of your IRA to fund QLACs, but with the total sum invested currently capped at $135,000. I funded three QLACs with payments starting at ages 76, 80 and 85.
I also used my traditional IRA to fund a “period certain” annuity. This annuity will pay me monthly income from age 62 through 69. I view it as my Social Security “bridge.” The annuity will pay me income while I delay claiming Social Security from age 62 to 70. At age 70, the period certain annuity stops paying income and I’ll file for Social Security benefits, at which point my benefit will be 76% larger in inflation-adjusted terms than it would have been if I’d filed at 62.
3. Rising interest rates. Once I’m retired, I want a more balanced portfolio, with less in stocks and more allocated to bonds. Problem is, interest rates are very low and seem poised to rise. If I reduce risk by holding bonds with short maturities, I’ll earn very little. If I go for bonds with longer maturities, yields aren’t much better, plus these bonds could decline sharply if rates rise.
My solution: Overfund a whole life “cash value” insurance policy. After six years of overfunding the cash value, my policy’s cash value is now projected to yield 3.5%. The beauty of cash value is that, as rates rise, the yield rises but the account value doesn’t decline—which would be the case with bonds.
In addition, if I don’t withdraw more than I paid in premiums, my withdrawals will be tax-free. I’m the first to admit that, if your goal is the maximum death benefit, term insurance is a far better bet. But if you’re looking for a bond substitute, cash value life insurance can be a good choice if you have the money available to overfund the policy—and if your policy offers that option.
4. Long-term-care costs. When I bought my cash value policy, I attempted to add a long-term-care (LTC) rider that would allow me to use my death benefit to pay LTC expenses. I’m still mobile—I play pickleball four days a week—but my insurance company still denied me coverage because of some past surgeries.
Fortunately, I was able to purchase hybrid LTC insurance from a different insurance company. That policy has locked-in premiums and should cover much or all of any LTC costs I incur. Having my LTC expenses covered removes one of retirement’s biggest financial uncertainties. For now, I’m also still funding a health savings account, arguably the most tax-favored account available. I can take tax-free withdrawals from the account to pay my annual LTC insurance premiums and my Medicare premiums.
Why didn’t I opt instead to pay any LTC costs out of pocket? I might have—if the only insurance choice was a traditional LTC policy where premiums can potentially rise sharply over time. But instead, I bought one of the new hybrid policies, where escalating premiums aren’t a risk. I also like the idea of prepaying potential LTC costs so, if I need assistance, I won’t delay getting help because I’m deterred by the expense involved.
Putting together the various pieces of my retirement puzzle, I feel I’ve created a plan where risk is minimized. This might seem like an odd goal, given that I spent much of my career coping with stock market risk. But as I head into retirement, my attitude has changed.
I spent decades measuring my investment performance on a daily, monthly and quarterly basis versus both competitors and market indexes. That can be exhausting emotionally. In 2008, during the financial market meltdown, my most positive workday was spent at a movie theater watching a double feature. In retirement, I want to travel overseas and play pickleball most mornings when I’m home—and I want to do these things without worrying about the stock market’s daily spasms.
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. Check out his earlier articles.
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Roboticus I would wait on QLAC’s till rates rise a little more. Yes I have the bulk of my portfolio in equities for inflation protection and growth. I was very skeptical of stand-alone LTC but researched hybrids enough to believe they will honor the commitment but if I hadn’t researched them thoroughly wouldn’t have bought either. On the life insurance it might work but it is all about overfunding. Thanks for your comments.
James, this is a very thought-provoking article, nicely done!
I assume you have considerable equity investments as well to fund much of your retirement, and that these insurance products then are designed to plug many of the risks that we all face going into retirement with equity-heavy assets.
I think I’m in synch with the first three items, though I’m not sure to what extent we will use annuities (such as QLACs).
I’m distrustful of LTC insurance. It has a somewhat troubled history, and seems to have enough loopholes and limitations that I’m skeptical of it’s usefulness. I suspect we’ll be better off self-insuring.
However, the over-funded life insurance could be a useful idea for us. We have been considering a life insurance policy to fund a trust for our special-needs son. What you’ve proposed sounds like a solution that could serve two purposes, both in funding the trust as well as cash returns in the interim.
Mickey that is a good question. For 6 years I was adding cash to the account and earning zero returns (even though I was entitled to a death benefit). The 3.5% is composed of investment returns and sharing in the insurance company’s earnings. Whole life policies charge a premium in excess of term policies and this excess is part of the 3.5%. When people cancel their whole life policies early (lapse) they lose this excess. By overfunding the policy I share in the insurance company’s profits. The 3.5% yield is low by historical standards. If rates on fixed income rise I would expect the 3.5% to increase. Unlike a bond if rates rise my cash value would not decline. So the trade-off is that it takes years to see a positive return and most people don’t have that patience.
So 3.5% on your cash value? Given that 10-year treasury rates are roughly half of that, what is the risk involved in getting that return? Under the theory that there’s no “free lunch” in investing, why are you expecting an above average return with this and what is the trade off? It may be an acceptable trade off for you, which is fine, but there *has* to be a trade off and that’s what I’m curious about.
Too many insurance suggestions presented for my taste and comfort but thank you.
You are welcome.
I wish you had explained this a little more. What are the benefits and drawbacks of this strategy?
How much did this annuity cost? What will it pay? What risk were you trying to mitigate? Why didn’t you just take IRA distributions for your Social Security “bridge.”
The period certain gave me more certainty than just withdrawing from portfolio. Returns higher than cash. Less flexible than leaving in cash as I gave up flexibility for the higher certain yield. I will receive 96 monthly payments and then start SS. The higher guaranteed yield and monthly certainty more important than the flexibility. Can compare yields from different companies which embed the different fees.
James, I set up the first Roth IRA years ago and am now over 65. Can I move money out of the Regular IRA into the Roth without worrying about the 5 year waiting rule? Others may have the same question. Thank you.
There are two five-year rules — one that applies to regular contributions and one to conversions. If you set up a Roth, that starts the five-year clock for all future contributions. But with a conversion, you start a new five-year clock for each converted sum. The good news: This is unlikely to be a problem if you’ve made earlier conversions and/or contributions, because you can tap those sums first. https://humbledollar.com/money-guide/roths-five-year-rule/
Yes. I wrote a Roth article recently here and that question came up and we dug into that particular question. If you have the account set up 5 years AND are over age 59.5 there is no more 5 year wait! There is no new 5 year clock.
Assuming you have a legal continuing power of attorney (which I’m sure you do), are they aware of all of these policies and plans and capable of implementing them on your behalf over the long term, if necessary.
Also, in my experience, the projected cash value of whole life insurance is often on the optimistic side.
Thanks Linda for reading. Yes to the first question. Fortunately I have lunch monthly with a life-long friend /CPA who would fill that role. You do make an excellent point regarding LTC though. I know of 2 instances where the children didn’t know there was a policy and didn’t use it. Elderly parents forget they have the policies. Regarding cash value projections I am assuming 3.5% even though projections show closer to 4%. In today’s rate environment that is still hard to beat.
I’m skeptical that a cash value life insurance policy is the best way to protect against inflation since part of the cost of the policy is to provide a death benefit.
The cash value is my bond substitute. You are correct that it is not the best way to protect against inflation.
I was referring to other bond substitutes that protect against inflation, such as a COLA annuity or a fixed level percent increase annuity (e.g. 3%). Did you compare the prices of these types of annuities to cash value life insurance?
No I did not. Also their yield would not be tax-free. What examples are you referring to?
I noticed the plan to convert a rollover IRA to a Roth IRA, avoiding future taxes and RMDs. I am doing that too, but am concerned about all the tax increase proposals coming out of Congress and the Biden regime and wonder if they will start taxing Roth IRA disbursements with the argument that the government needs the money more than you do. Anyone else see this as a possibility? I hope I am worrying about nothing.
Roths are funded with after-tax money. If Congress decided to tax the disbursements as well, then there would be absolutely no reason to put money into a Roth. I’m hopeful that even our financially-illiterate Congress will recognize that it would be political suicide to change the rules on Roths.
Rick Edelman says never convert IRA to Roth because you are giving IRS money now. Also the congress can change Roth to taxable any time. Some life insurance is not paying because the V is a pandemic.
I see that Ric Edeman doesn’t like Roth conversions on his radio shows. Since I want my account to grow I prefer paying taxes on a smaller amount today than a larger amount in the future. Paying tax on the seed not the tree.If you do not trust Congress to keep rates down I would think paying now versus letting a future Congress raise rates later would be preferable. Letting a tax-deferred IRA grow seems riskier to me. Choose your poison.
I worry about that too. I expect eventually Congress will find a way to make them less attractive. That is why it is vital to gradually convert at a lower tax rate than doing it all at once. My Roth accounts are growing tax-free but my tax-deferred IRA is creating a larger tax bill for me evn if Congress does nothing. I do believe the life insurance lobby will protect my cash value policy taxwise. They have been around since the Civil War.
Thank you James for sharing your plan. Your comments on possible tax increases cause me to rethink not making a Roth conversion now.
I’m not a financial planner so my comments may not be expressed accurately, but I wonder how efficient this plan is in terms of expenses and returns. Specifically, I wonder how the returns on your plan project compared to a 70%/30% stock/bond index fund allocation that never changes, which is my plan as I expect to live a long time and don’t want to run out of money.
That said, your LTC strategy is interesting and I’m going to give it further thought. Now, based on family health history, I plan to self-fund any long-term care, perhaps putting the home in a “Medicaid Trust” to at least preserve that for my heirs if I completely run out of money.
Boss Hogg as I have grown my Roth IRA over 6 years I become more convinced that more people should look at the possibility of doing so. My tax bracket was very low so it made my choice easier. The first step is opening a Roth account and converting a small amount. I have written an article on Roth conversions here as well.
This is the first time I recall being confused by the observations and advice in this column going back to my initial subscription to the Wall Street Journal more than 20 years ago. (1) Why isn’t it clearer that hyper-inflation is the greatest threat to people who are retired? People tend to think there could never be another Weimar Republic, but there are many modern, as well as ancient, precedents. A quick internet search shows four countries with current inflation rates over 100%. Does anybody remember when some of our “allies”, such as Israel had inflation rates of over 400%? (The writer of this column should be old enough to remember when Israeli inflation peaked in 1984 at 486%) American inflation approached 20% after WW1. Do we think there will never be another catastrophe (like COVID, Krakatoa, or the grounding of a tanker in the Suez Canal?) (2) Why isn’t it clearer that long-term care insurance companies not only can, but have, gone through restructurings, and even bankruptcies? The benefits that my 90-something year old parents receive from paying in for 40 years are now limited to a nurse’s aid for one hour three times a week, and a nurse for about a half-hour once a week. (That’s not what they were promised. We survive by paying cash-out-of-pocket for enough help for them to live at home.) So, why would a sixty-something year old like me buy long-term care insurance? (Fortunately, one of my colleagues, who was also a DIYer when it came to financial planning, convinced me to sell the LTC policy I bought in my 30’s when I was 40-something.) (3) It’s just hard to understand how any fiat currency cannot be confiscated, including cryptocurrencies. (4) Housing doesn’t seem like “real” estate right now. So, why isn’t the recommendation to buy equities? Large caps, small caps, internationals, etc. Why isn’t a balanced portfolio enough cash in FDIC insured bank accounts to survive 12-months come hell-or-high water, a few guns and boxes of ammunition that can be bartered, while everything else sits in index funds? Why does this column seem to imply that stocks are more volatile than other asset classes, when it seems to lay people like me that stocks are the only “real” estate?
Series I savings bonds are a great option to protect against inflation. Interest rates are adjusted for inflation every 6 months. They also protect against deflation (0% rate floor), have favorable tax treatment, are backed by the US government, and are easy to buy and sell (with no fees). There are annual purchase limits, but a nice cash reserve can be built up over several years.
Jamie what are the returns for the I bonds? I see latest returns at 1.68%? What is the favorable tax treatment-that I can defer the interest?
I agree that equities are the best protection against inflation. Those are in my Roth account tax-free and a brokerage account. I have the volatility offset by the cash value life insurance. If you recall 1 year ago equities were extremely volatile but offset by the Federal Reserve backstopping every asset available which can lead to the inflation we fear.
I fully agree with your sentiments. I don’t over insure and 40 years of building and now living off my portfolio assets has given me the confidence I need to successfully DIY my personal finances. I have always had a great interest in personal finance topics and consider myself highly educated in the specific areas of my interest. I don’t expect that most folks (as I’ve learned through family and friends) will be as interested or motivated to successfully do the same.
James McGlynn, not to be a paranoid, but with all the annuitization in your plan it seems you’ve added a fifth source of risk, that bad things happen to the insurance industry and companies.
That could be painful if someone had most of their eggs in those baskets
It pays to be paranoid! I have worked for different insurance companies in their invstment departments and know they are regulated more than most companies.The insurance companies are rated by AM Best, Standard and Poors, Fitch and Moody’s. There is a rating called COMDEX that is a composite score of these 4. COMDEX scores range from 100 to 0. I purchased my QLAC from an insurance company rated 100. My whole life policy was purchased from a company rated 98. My LTC policy was purchased from a company rated 95. My period certain annuity was from a lower rated insurance company only rated 84. (Less worried about this annuity as short duration.) I diversified among 4 different insurance companies. There are state funds that can backstop insolvent companies as well. I am also worried about Social Security, higher taxes, Medicare, inflation…
Check Weiss ratings.