For weeks, we have been discussing the perils facing pre-retirees as they look toward retirement. Let’s review. Without a Defined Benefit Pension Plan most private sector workers are left to accumulate assets in a Defined Contribution Plan (401k’s, 403b’s, etc.) or an IRA (SEP, Simple, Roth, etc.).
These qualified plans are left to the interest rate/rate of return financial power alone, absent of any actuarial science. Without actuarial science these plan structures create a host of problems, an example being the lack of mortality credits. Other problems are withdrawal rate risk and difficulties associated with the sequencing of returns in a fluctuating interest rate environment. The best research suggests that a retiree should not withdraw more than 3.5% from his portfolio each year. Some research even suggests 2.8%! Otherwise, there is a strong probability he will run out of money. Previous articles have referenced a host of reputable sources that supports these conclusions.
What does this mean as one enters retirement? A $1,000,000 nest egg will only yield $35,000 of annual retirement income ($1,000,000 x 3.5%)! This income is woefully short of most expectations. If only $500,000 is saved, this will generate just $1,458 per month. Even with Social Security, a senior couple will still be forced to live on only a fraction of what they are used to earning.
The bottom line is this! Retirement assets by themselves have a very difficult time getting down the retirement mountain. This suggests that one must have another asset that is uncorrelated to traditional retirement assets. Once positioned, these two separate assets can interact with one another creating the ability to take much higher income rates (7-13%). This can obviously produce far more income in retirement. By simply repositioning savings in pre-retirement, a retiree can achieve a higher retirement income target and do so on a guaranteed basis.
Let me show you how!
Let’s assume a pre-retiree saves just $750,000 in his 401k plan. This is $250,000 less than our previous $1,000,000 example. Let’s also assume that while in his 40’s or 50’s the pre-retiree repositions the other $250,000 into a Whole Life Insurance contract. This policy would have a targeted death benefit of $750,000 with a related cash value of approximately $250,000 at age 65. This policy design can be accomplished even with an average health rating, but must be structured properly with the right product specifications and with a top rated company.
Why Whole Life Insurance? In short, Whole Life Insurance has certain specific attributes and guarantees that make it an essential fit for solving a pre-retirees retirement income dilemma.
Having laid these two cornerstones in place ($750,000 in Retirement Assets and $750,000 in Whole Life Death Benefit), the retiree now has several options that he did not have before. Let’s discuss one option. I will call this the Covered Retirement Asset Option.
A Covered Retirement Asset Option is one that is accompanied by an equal amount of Whole Life Death Benefit. Similar to how most government entities provide retirement pensions to their employees, covered retirement assets lay the foundation for self-made pensions in retirement.
This is accomplished through the interaction of a retirement tool that is unrelated to withdrawal rate simulation curves. This is called a Single Premium Income Annuity (self-made pension) made possible by the Whole Life Death Benefit. The central advantage to this instrument is rooted in actuarial science, which is the same financial power used in Defined Benefit Pension Plans.
Under this option the interaction of the Retirement Assets and Whole Life Death Benefit gives the retiree the ability to create a guaranteed retirement paycheck for life historically in the range of 7-13%. This also provides a perpetuation of retirement income for a spouse and/or a legacy for heirs.
Here is the application. At age 65 the pre-retiree has the option to trade his $750,000 401k for a Single Premium Immediate Annuity (SPIA). As noted, these instruments have historically paid from 7-13% for a 65 year-old male. Let’s assume a reasonable 10% payout rate. The retiree will now begin receiving an annual guaranteed paycheck of $75,000 for life ($750,000 x 10%). Did we not just significantly increase the pre-retiree’s income? Remember the $35,000?
As long as the retiree lives he will receive a contractual $75,000 annual paycheck! When he passes the SPIA stops! Now is when the Whole Life Death Benefit serves its purpose. A death benefit of $750,000 is paid tax free to the surviving spouse! At this point, the surviving spouse has a plethora of very favorable options to maintain an on-going guaranteed lifetime retirement income.
Let’s tally the results! First, the pre-retiree’s retirement income has increased from $35,000 to $75,000! Second, retirement income has shifted from non-guaranteed to guaranteed. Third, the pre-retiree did not spend any more money in pre-retirement to accomplish the result, he simply re-positioned current savings differently over a period of time. And finally, he has a credible claim on financial peace knowing that his retirement plan is secure. Mission accomplished!