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Rethinking The Traditional Retirement Planning Approach: Two Alternative Strategies

President and CEO of SunCor Financial, LLC.

The retirement planning industry needs to evolve. The core 401(k) plan and individual retirement account (IRA) strategies that make up most people’s retirement funding made sense 40 years ago. However, they may not be the best performing vehicles in terms of producing retirement income. Why? These plans are more investment-focused rather than retirement-focused.

These vehicles have the potential to make money over time, like any investment, but as the founder of a life insurance-focused retirement services company, I believe the structure and focus are flawed. IRAs and 401(k) plans often do not produce enough income during retirement because they were designed backwards. In traditional retirement planning, there are three phases that determine how much retirement income a plan will produce.

Building A Nest Egg

The first phase of retirement planning is the accumulation phase, or building a nest egg through a mix of index and mutual funds, exchange-traded funds and other stock and bond investments. Depending on the allocation mix, an investor is generally looking to earn 8% to 12% per year. In exchange for this growth, there is a considerable risk and year-over-year volatility.

Financial plans and planners generally focus on the accumulation phase. It is exciting for investors to see their money grow and look at projections that show considerable sums if they stay the course (and earn a repeatable interest rate). However, the question remains: Does this phase and reliance on stocks and bonds really produce the most consistent income in retirement?

Managing Returns And Risk

The second phase involves “tapering off” the asset allocation mix. To build consistency into a portfolio, the investor/planner converts some of the stock allocation into bonds and other secure investments. This functions as a hedge against big drops in the stock market, which can last for a few years in recessionary times. As an investor enters retirement age, the portfolio allocation shifts further, moving toward a classic 50/50 stocks and bonds mix. I call this the “sprint, run, jog, walk” method of investing.

Pulling Out Funds

The third, or distribution, phase is where problems arise for many investors. IRAs and 401(k) investment plans are designed with so much emphasis on the accumulation phase that the distribution percentage suffers. The “4% Rule,” widely accepted in the retirement planning community, does not produce enough income for many retirees’ needs. The 4% figure is considered the “safe withdrawal rate” and is the advised amount to withdraw per year without risking early depletion of one’s nest egg. This limited withdrawal amount requires many retired Americans to downsize their lifestyles. Even if they have reached the “holy grail” million-dollar nest egg, an amount achieved by only around 1.6% of 401(k) and IRA account holders, they are looking at $40,000 per year in non-Social Security retirement income.

Traditional investment-based retirement planning does not focus enough on retirement income, which leaves many retirees frustrated and confused.

A Different Approach

An alternative to the three-tiered strategy above is to focus on maximum distributions, rather than accumulations. There are two mainstream strategies outside 401(k) plans and IRAs that can accomplish this: real estate investment and max-funded life insurance contracts, also referred to as max-funded, option B indexed universal life (IUL) plans. Both start off with seemingly less growth potential, but can ultimately produce significantly more income.

Real estate has the advantage of being a hard asset. Investors like the security of actually seeing their assets. While growth appreciation tends to be modest, investors have the opportunity to utilize a home equity line of credit (HELOC). A HELOC allows access to additional capital from a bank, at a low interest cost, which can be used for more real estate investments.

This method does have risks. As evidenced in 2008, home equities can drop significantly depending on the market, a liability for those who can’t meet their obligations. Real estate investments are also subject to capital gains or income tax, and require a lot of time and expertise to build a profitable portfolio.

The second strategy is the IUL plan. An IUL is a tax-advantaged plan similar to a Roth IRA. The money in it is post-tax, meaning the income produced can be tax-free, eliminates exposure to capital gains on the growth and distributions and provides beneficiaries with tax-free proceeds of both the cash value and life insurance contract. These plans are not constrained by the 59 ½ year age restriction or early withdrawal penalties of traditional plans.

Like real estate, IUL plans start slowly, with an accumulation phase built on security. Inside the IUL contract, the insurance company offers a contractual guarantee that no matter the market risk or volatility, the retiree has a 0% floor, meaning they can never receive less than 0% earnings in any given year. Similar to a HELOC, an IUL plan can offer a retirement equity line of credit. This provides capital directly from the life insurance company at a low interest rate, using the cash value in the IUL as permanent collateral to be paid back at time of passing. With the additional capital, savers can increase the size of the life insurance-based retirement plan, accelerating returns as it matures over time.

There are drawbacks to the line of credit enhanced IUL plan. Not everyone qualifies, due to a health component requirement that does not exist in traditional retirement plans. As with any leverage plan, market risk does play a factor. However, the plan’s 0% floor guarantee protects your assets from losing any principal value.

Neither real estate, nor the IUL will produce a large nest egg overnight. Both mature slowly, taking up to 10 years to see significant increases in your account value. However, through the additional benefits of the line of credit features, these strategies have the potential to provide significantly more retirement income through secure accumulation, acceleration over time and maximized distribution.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation. 


Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. Do I qualify?


Source: Forbes – Money

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