Sometimes Time Is On Your Side: Making Your Investment Work Twice as Hard For Your Family
Trying to balance work, children and anything resembling a personal life can sometimes feel impossible. Days rush by while dreams disappear into the future. Your budget feels stretched to the limit. How is it possible to keep the household expenses paid, pay for life insurance to protect the family in case you or your spouse pass away, put money away for the kids’ college costs, and still save for retirement? If this is happening to you and your children are high school age or younger, options may be here.
Saving For College - In Under 10 Years
Consider Tom and Susan, who are in their 50s, and their two children, Kate and Marcus (no real names used), who are just getting to high school high school age. Time is running out to fund college, but Tom and Susan are already paying for life insurance in case one of them passes away unexpectedly and investing in the retirement savings plans at work. With all the household bills to pay, they can’t figure out how to put together enough money to help the kids get through college. Kate, who just started 9th grade, is a math wiz with a passion for physics. Marcus, still in 7th grade, would rather get his hands into what he’s working on and dreams of being a mechanical engineer like his dad. More than anything, Tom and Susan want to help the kids get the college degrees they will need, but they don’t want to sacrifice their own dreams of a retiring to a little home on the beach to do it.
Right now, time is still on their side. Like a snowball rolling down a snowy hill, invested money can grow bigger faster the bigger it gets and the longer the hill it travels down. A tiny snowball is too small to pick up a lot of snow from the ground but the snow it does pick up makes it bigger. The more snow on the ground and the longer the hill, the bigger the snowball becomes with each roll. Look at the hill as time, the little snowball as the initial investment and the amount of snow on the hill as how well the investment is doing.
If Tom and Susan start saving now, they have up to 7 years before Kate’s bachelor’s degree is done and those college loan bills start rolling in. And 9 years for Marcus’s bachelor degree to finish. Applying for financial aid won’t be affected by an investment in life insurance, so the money can grow while Kate and Marcus are in school and able to apply for college loans. That’s not a bad hill to roll a snowball down!
That all sounds good in theory, but how do you find an investment strategy that has enough growth over the short term to pull money out for the kids’ college costs, but is low risk enough for long term growth to supplement your retirement income - all while providing a bit of a safety net in case a parent passes away before the kids are grown?
How Can Life Insurance Help Pay For College?
One powerful and often overlooked strategy is to invest in an accumulation-focused, indexed universal life insurance policy. These days, it seems like there’s a life insurance policy for everything. It’s useful to think about 3 basic categories for the new “flavors” of life insurance. (Snow cones? As long as we’re in the snow analogies ...)
- Growth - focused on increasing investments rather than taking income
- Accumulation - focused on building cash value to take for income or things like college payments
- Protection – focused on maximizing the living benefit to pay cash for long term chronic care, immediate terminal care or even short term critical care.
Each type of policy has pros and cons. But if you’re looking to solve more than one problem with a single premium payment, the new flavors of life insurance offer stronger benefits than the older death benefit focused policies.
So - what are we looking for? In this case, we’re looking to withdraw cash while maintaining a death benefit - and we want the cash for two different time frames. A shorter “hill” for the kids’ college costs and a longer “hill” for the parents’ retirement costs.
Our Experience and Lessons Learned
Accumulation life insurance, focusing on cash withdrawals, can provide both those goals when adequately funded. And there’s the key, “adequately funded”. Back when we were younger (a lot younger!) my husband and I were in our boom days with our small consulting company. We asked our CPA for a tax shelter for a windfall we received that year so we could save that money for retirement. He referred us to a life insurance agent who signed us up for an indexed universal life insurance policy. Trusting the referral, we dumped our windfall into the plan.
5 years later, we decided it was time for a review. (Yeah, a little late.) We discovered that the agent had disappeared, and our unwatched investment was being eaten away by insurance fees. The index he’d started us in was performing poorly – we were naïve and didn’t understand indexes. We looked at them as predictable interest, like a CD would provide, so we failed to keep an eye on them. The agent had failed to explain to us that the insurance plan he’d set us up with was designed to be managed and to be “max-funded” year after year to build a cash value that could be withdrawn tax free in retirement. Instead, we ended up rolling the shrunken cash value into another, more practical policy.
Moral of the story, know what you’re investing in. Since becoming an insurance agent, I’ve had several clients tell a similar story. So why am I recommending a strategy that failed for me? Because it was ignorance that caused the strategy to fail. I wish I’d understood the policy back then. If we’d used the policy properly, we could have had a stronger college fund for our son and more cash available for our retirement. My mission here is to offer you the lessons I’ve learned so your story is a happier one!
Using Life Insurance for Tax-Free Income
Let’s dive into the details of this strategy. First of all, it relies on regular premium payments, time and interest based on stock market indexes to build. The premiums paid are more than what’s required to maintain the life insurance policy, but less than the amount that will change a non-taxable withdrawal into a taxable one (making a MEC out of the policy). That premium amount is the maximum funding allowed by regulation to avoid creating a Modified Endowment Contract (MEC). The policy requires some attention – typically you’ll receive an annual statement asking if you want to change which indexes you’re using. The policies almost always offer several to choose from and some companies even provide a performance history. You can ask your agent and/or investment advisor for some help with that.
When the time comes to withdraw money, you withdraw it as a non-taxable loan. To ensure you leave enough money in the policy to keep it in force and growing ask for a current illustration which shows the effect of the amount you plan to withdraw. The loan is drawn against the cash value of the policy and, if the life insurance plan is favorably set up, the loan interest pays for itself until the policy owner passes away. (At Retirement Safety Zone, we’ve got your back on policies with favorable terms.)
Growth to support cash withdrawals that don’t increase income tax are the strongest feature of Accumulation policies. Your family can withdraw funds for college and later funds for retirement. Assuming you’ve been prudent about withdrawals and allowed enough time both to build up cash and to recover from any zero-interest years due to bad stock market performance (keep in mind, with indexes you NEVER get a negative interest rate), you can choose to stop paying premiums - you get to decide when although typically people choose to stop payments when they retire. At that point, you can start regular loan withdrawals to fatten up your retirement income. Or use the cash of the policy for bucket list adventures, starting a dream business, or remodeling the house.
Accumulation polices aren’t focused on death benefits, so it’s not a strong feature. However, since we’re also looking to shelter the family from losing their home or ability to pay the bills if one parent passes away early, the death benefit is a critical factor. This type of policy doesn’t have a fixed death benefit. It grows or shrinks based on withdrawals and index-based interest growth. As long as the cash value doesn’t go to zero, you have a death benefit to help the family over the shock and financial strain of losing a parent and income earner. Depending upon family income sources, one or both parents might consider a shorter, smaller term life insurance policy to boost protection against losing the house or not being able to pay the bills.
Strategy at a Glance
Buying an accumulation, indexed life insurance policy can be a powerful way to create tax free cash for your family but it won’t work for everyone. You need a long enough hill (enough time) and enough snow on the hill (money to keep paying the maxed-out premiums) in order to keep cash building in the policy. Taking money out is the fun part, but requires some care to make sure that snowball keeps growing (leave enough cash in the policy to build on).
Next Steps
Although we’ve only discussed college funds and retirement income in this article, there are many ways to use the cash building in the accumulation policy. What do you want cash for?Every family has different needs. Set a time to see if this strategy will work for your family below. Our consultations are no-cost and no-commitment.
Have questions? Email us at getinfo@retirementsafetyzone.com or give us a call at 970-294-1297. We can't wait to hear from you.