Life Insurance - A Good Retirement Planning Alternative
Retirement (Photo credit: 401K 2012)
One of the drawbacks of traditional retirement accounts such as IRA's and 401(k)'s is the fact that they require minimum distributions, whether you need the money or not, after age 70 1/2. In addition, the withdrawals are taxed as ordinary income at the tax rates in effect at the time. Your reward for being an excellent investor is to pay much of what you make in investment earnings back to the government in taxes. It seems unlikely that tax rates will be lower in the future than they are today with all of the borrowing our government is doing, so the notion that somehow you will be in a lower tax bracket in retirement doesn't make as much sense anymore.
An interesting alternative retirement plan idea is to buy a life insurance policy with a very low death benefit. You then pay the maximum premium allowable under IRS guidelines, without the policy becoming a Modified Endowment Contract or "MEC," where distributions including policy loans become taxable and potentially subject to penalties. The cash surrender value of the policy grows tax free. Funds can then be withdrawn in retirement by taking out loans against the policy (loans are not taxable). The loans would then be repaid out of the death benefit, with any excess paid to the beneficiaries of the policy.
A great book on this subject is Missed Fortune 101: A Starter Kit to Becoming a Millionaire, by Douglas R. Andrew. You must be willing to commit some time to understanding life insurance, which can be challenging. You will also need to consult with your tax advisor to make sure there are no issues in your specific situation. You may cringe when the author suggests that you borrow out your home equity as a source of funding for the up-front life insurance premium payments. At the same time, the concept that home equity is neither liquid nor safe is not lost on most of us having survived the Great Recession.
One of the biggest advantages to the life insurance retirement plan is that you are not required to take minimum distributions with an insurance policy and as mentioned previously, policy loans are not taxable as long as the policy is not a "MEC." You have to have confidence in the investment prowess and business savvy of the insurance company you choose to issue the policy. The good news is that insurance companies fare pretty well - just look at how many banks failed in the current downturn versus insurance companies. Also, insurance companies tend to be fairly conservative in their overall investment portfolios.
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