Whole life insurance policies can play an important role in your retirement income planning. This statement may run counter to the advice you see offered by investment salespeople, but I think we’ve shown many examples over the last decade that whole life insurance not only works as a retirement income tool, but it does the job exceptionally well.
But there is something else that we haven̵7;t spent much time talking about. Something “baked in” to whole life insurance that puts it in a strong position to deal with rising costs in retirement.
How do people generate income with whole life insurance?
Maybe you’ve seen a whole life insurance proposal—we often call them “illustrations”—and in that proposal you saw a static income figure spanning a period like the mid-60s to the mid-80s. You might have thought, “hey, that’s cool. I can retire and then get X amount of dollars every year from this life insurance policy.”
But the truth is, people rarely ever do.
Generally, retirees use their assets to generate the income they need – and that’s it.
Whole life insurance is no different in this regard. So while a policy may provide a certain amount of income, most people tend to use a number less than that.
And taking less money from a whole life policy comes with an added benefit for later in life. Let’s look at an example.
Lifetime Income Example
This statement shows the income performance of a 40-year-old man who buys a whole life policy and contributes $30,000 per year to the policy through age 65. At age 66, he begins using the whole life insurance policy for retirement income. This statement shows us the maximum income available to him from age 66 to age 100 – the statement above is an extract from the full statement.
As you can see, he can produce up to $72,561 per year with his whole life insurance, which isn’t bad at all.
But what if this individual doesn’t need the $72,561 in income from their whole life insurance policy. What if he only needs $40,000 a year when retirement begins?
This is how it looks:
Here we see if he uses his whole life insurance to cover $40,000 in income needs, he could increase the income to $100,577 per year after the first 10 years of his retirement. This higher income is sustainable – at current dividends – until he is 100 years old.
With this approach, at age 100, he would produce about 15% more income from his policy compared to taking the maximum amount—$72,561 per year—from retirement through age 100. That difference in dollars is approximately $375,000.
Whole life insurance income is guaranteed to be better
Some of the more savvy readers will likely think to themselves that there is no magic here. After all, if I have $1.4 million in stocks and bonds and if I withdraw a low relative amount toward that balance as retirement income, I can do the same thing—increase my income later. To this I would say, yes…theoretically speaking.
You see stocks and bonds Power give a similar result. If we model something with a static return for a hypothetical stock/bond portfolio, that exercise will surely tell us that this phenomenon exists with that retirement plan as well. But the difference—it’s subtle but very important—is that stocks and bonds aren’t designed to do the same thing that whole life insurance is.
All life insurance comes improve over time. It is contractually guaranteed to do so. Each year you achieve a non-guaranteed result with a lifetime contract, the resulting guaranteed components improve for all years to come. So taking less income now with the promise of a higher income capacity in the future is exactly how whole life insurance works.
Stocks and bonds, on the other hand, are only capable of this task if the return is still positive. This scenario that plays out with stocks and bonds also depends on the timing of returns—perhaps we should call them, the sequence of returns—on the investment. You may have retired and taken an income that no one would consider dangerously high. You may also experience a market correction that brings your account balance uncomfortably close to requiring a revision of your safe withdrawal rate – perhaps something people are dealing with these days – and this will not allow for a higher withdrawal rate after years of lower income.
But whole life insurance is different. There is no “correction” event with whole life insurance. When the markets pull back, whole life insurance marches forward, mostly unaffected in the meantime. Now, major economic forces can ultimately affect the overall direction of the entire life insurance distribution. We witnessed this play out from about 2009 to the present. Continuous monetary “easing” by the Federal Reserve pushed interest rates to a new level, ultimately affecting whole life insurance payouts. But it took a long time to materialize – and most dividend-paying life insurance policies continue to compete favorably with similar savings plans with risk profiles.
That being said, it is foolish to overlook the unhindered progression that whole life insurance policies are designed to have. Taking less income today from your whole life insurance does not sacrifice the maximum you have available to you. Although the dividend is reduced, the guaranteed properties of the contract are the primary drivers of this attribute.