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Life Insurance is not a Retirement Plan

Friday, May 13, 2016

By David I. Katz, AAMS®, COO, CFO Financial Planner

Recently I was asked, to weigh in on life insurance policies in general and more specifically, their place in the retirement planning process.  While at first the topic might not seem directly on point for a retirement planning, many life insurance policies are sold under the guise of saving for retirement.

Should life insurance be a key part of your retirement plan? Life insurance should be a vital part of your overall financial plan, specifically, if people depend on your income (e.g. your children and your spouse). A sizable income tax free life insurance death benefit payment is the best way to maximize the chance that your dependent's standard of living is not dramatically reduced due to your untimely demise. In fact, income replacement is the number one factor couples site as a reason for purchasing life insurance.

Then the question becomes, what type of insurance should you purchase and is it a good idea to use insurance as an investment for retirement. If you listen to Suze Orman, Rick Edelman or other self proclaimed financial gurus the answer you will get is that there is no reason to buy anything other than term insurance and that permanent insurance helps no one except the agent/advisor that sold the policy. Others will argue that term insurance is a temporary fix and since in generally offers no equity it is like renting an apartment versus buying a home and that you are throwing you money away. Insurance industry legend Bob Castigione, creator of the LEAP selling system, will posit that every investment dollar that you have should be invested in permanent whole life insurance. The truth actually is somewhere in between.

When you purchase life insurance to protect your family, you'll want to be sure you buy adequatecoverage.  First and foremost, you want to make sure that if you die there is adequate funds available to take care of your family financially. For many people, that means purchasing Term Insurance which is the most affordable type of life insurance.  Others may still consider permanent insurance (Whole Life, Universal and Variable Universal) because they are drawn to the cash value (equity) that the policy builds over time. The problem is that purchasing the cash value insurance, however well intentioned may leave the family at risk. Let’s take an example of a male age 35 that is in good health and purchases a $1,000,000 whole life insurance policy from a (A+) rated insurance company. His premium as a select preferred rating will be approximately $10,960 per year. The policy will build cash value on a guaranteed basis and may build additional cash value based on what the policy owner chooses to do with any non-guaranteed dividends the company may pay each year.  Over time, the policy will build cash value in excess of the actual premiums that were paid. But what if he dies? As Shakespeare so aptly put it, “there’s the rub”. The family will still receive only the death benefit portion (which may increase over time if dividends are paid and used to purchase additional insurance) and not the cash value/savings portion.

The same 35 year old man could use the $10,960 premium to purchase a 20 year level term insurance policy with a death benefit of more than $15,000,000.  I have been in the financial services business for more than twenty years. At the insured’s funeral no one has ever asked me if the deceased had the “good kind of insurance that builds cash”. All they want to know is if there is enough to take care of the family.

This hypothetical 35 year old man may opt for another strategy. Purchase a lower cost $5,000,000 20 year term life insurance policy and invest the cost savings into his company 401(k) plan. In this case, the approximately $3,000 term insurance premium would afford the individual a $7,960 cost savings. Because of the pre-tax nature of 401k investments, the man would be able to invest $12,000 into his 401(k) plan for the same $7,960 net cost. At the end of the day, he will have five times the insurance protection for his family and a pre-tax deposit of $12,000 going into his 401(k) plan. Caution: This “buy term and invest the difference” strategy only works if you invest the difference. That means either enrolling in or increasing the contributions to your 401(k) or other retirement plan. If you aren’t afforded a plan through your employer, or if you are self employed, there are other retirement investments designed for you that will give you the same net result. Contact your advisor to review their appropriateness and merits.

With the advent of buy term and invest the difference insurance companies began marketing a product called Variable Universal Life Insurance (VUL),which is a hybrid type product and accomplishes the buy term and invest the difference within one plan. Advisors point out the fact that the fact that Variable Universal Lifeallows the policy owner to choose from an array of separate accounts (mutual funds that are part of the insurance policy). They discuss the tax advantages of the policy (tax deferred growth with tax free access via policy loans). With VUL the individual takes on more risk and has potential of a higher reward in a bull stock market but will also participate in lower returns in a down or bear market.  However, the internal costs associated with the policy, including the increasing cost per thousand of insurance reduces the amount of your premium dollars that are actually invested into the separate accounts.

So is permanent insurance appropriate as a retirement investment? The answer is not an easy one because of all the potential pitfalls, however, you can begin by asking the question; Do the tax benefits outweigh the costs? The costs associated with permanent polices, which are used to pay commissions, marketing costs etc. are so cumbersome that in many cases the tax benefits are mitigated. Furthermore, since after you withdrawal your cost basis from the policy, you must affect policy loans to benefit from tax free withdrawals, you run the very real risk of an IRS nightmare. If the policy lapses and there are outstanding loans, every dollar of the loans will be taxed as ordinary income to the policy owner.  Imagine a situation where you are making $30,000 tax free annual withdrawals from your VUL policy for the first ten years of retirement and negative market returns, coupled with increased cost of insurance and policy loan interest eating away at the policy’s cash value cause an unintentional lapse.  You no longer have insurance, but what you do have is a 1099 from the company for $300,000.

Another risk inherent in the Life Insurance Retirement Plan (LIRP) concept is the possibility that, in an attempt to maximize retirement savings, the policy will be incorrectly overfunded, resulting in the policy being classified as a Modified Endowment Contract, (MEC).  Under the current law, money taken from a MEC in the form of policy or premium loans, partial surrenders, assignments, pledges, withdrawals, or loans secured by the policy are subject to income tax and possibly penalties.  Once classified as a MEC, a policy remains a MEC. The policy status doesn't change even if the policy is changed, adjusted, or reconfigured as a policy that would not otherwise be considered a MEC. A policy received in exchange for a MEC is also considered a MEC, even if the policy received under the exchange wouldn't otherwise be considered a MEC. Yeesh! What a mess. The very tax advantage you bought the policy for is now permanently eliminated.

Something else to consider;  although insurance plans are sold as more liquid than aretirement plan, in many cases they have exorbitant and extended early withdrawal charge that may prevent the policy owner from using the funds for 10 years or more.

But a properly structured LIRP can dilute the effect of fees by aggressively overfunding the policy. The more money that is fed into the policy, the lower fees will be as a percentage of deposits. Policies that charge per deposit fees of 6 percent are obviously not good candidates for a LIRP.

The drawbacks of a using a LIRP as a supplemental retirement savings vehicle are less pronounced for high-net-worth families that have already maximized other tax-advantaged retirement accounts. The question for those clients is whether the fees associated with a VUL policy erase the program’s tax advantaged benefits. The key is that they are normally only a supplement to an otherwise robust retirement plan.

In closing, if the insured does not have a need for life insurance, the high fees associated with permanent insurance policies can limit the growth of your retirement savings. The potential tax consequences of not properly maintain a plan can be devastating.

Low cost term insurance sufficient to cover their family and business needs is a recommendation most planners should make. Maximizing the tax favored retirement investment options that are available while still having enough to live comfortablyis another. Only then should you begin looking at alternative options for investment dollars.

David Katz is the Chief Financial Officer of Gitterman & Associates Wealth Management a
financial and wealth planning firm located in Boca Raton.  David can be reached at 561-826-9341 or

Securities Offered through Triad Advisors Inc. Member FINRA/SIPC

Investment Advisory Services offered through Gitterman & Associates Wealth Management, LLC., a Registered Investment Advisor which is not affiliated with Triad Advisors Inc.


10-Dec-2012 03:25 PM

While this comment may never see the light of day I needed to reply to this post. There are so many inaccurate statements and twisting of the fiscal reality of using permanent life insurance I couldn't leave without a post. The author shows the same lack of knowledge and understanding of this topic as Dave Ramsey and Suzie Orman whom he quotes. Mr. Katz must have studied permanent life policies in the mid 90's as he talks about Variable Universal Life mostly. While I will agree that this is a failed product for the reason's he states (and there are many many more) you cannot equate those policies with modern Universal Life, Indexed Universal Life and whole life policies. The in accuracies are too numerous to address in full here, but just the discussion of the tax consequences of lapsing a policy doesn't acknowledge that there are now overloan protections in many policies to prevent this from occuring. Also, most carriers will not accept a premium that would turn a policy into a MEC without written acknolegement of that from the client. They simply send back the check with a letter. While I agree that first and foremost you should focus on the amount of coverage to protect the family, business, estate, etc. Permanent Life insurance can greatly reduce risk in a retirement portfolio.

Roger Gainer
16-Jan-2013 07:43 AM

I believe unfortunately here that there are too many assumptions made and not enough understanding of the permanent products available today. The author gives an example of buying a 20 year term policy and investing the rest in a 401K and then states that when someone passes that the question is not what type of coverage did the deceased have it is where's the death benefit. The first problem is if the insured dies in year 21 or after, the answer is that the death benefit expired (which is the biggest waste of premium dollars there is). Not to mention that 98% of all term policies expire unpaid. Secondly if the insured wants to invest more then the 401K limits, he/she can't. Finally (while i realize tax deferred growth is a very powerful benefit) if the insured lives a long life and is looking for tax savings later in retirement the 401K will not provide that either as it is taxed upon distribution. While I agree fully that the first thing that has to be considered when purchasing life insurance is the need for a death benefit for the familys protection, I don't believe you can weigh any other aspects with blanket assumptions as each family's needs are different and there is no cookie cutter way to use life insurance.

16-Jan-2013 12:28 PM

Yea, to both of your comments. I agree with both of you. Mr. Katz needs to go get re educated on what's out there now for clients instead of giving clients bad information. Like I mentioned earlier, he needs to read the book "Tax Free Retirement by Patrick Kelly" but he also needs to talk to other financial advisors and get up to date on what we should now be offering to clients and term is not the answer because most people will not invest the difference, they will spend the difference and then when retirement age comes around, they will be left out in the cold.

16-Jan-2013 02:37 PM

As stated above, Mr Katz doesn't know as much as he thinks. He talked a lot about VUL, variable universal life insurance. Those are not the right policies to use for retirement because of the cost and risk involved. There are other options better suited. Most financial planners just don't want to put in the time and effort to really understand cash value life insurance other than what traditionally is believed. If buy term and invest the difference was so great, why do so many Americans save so little and are under insured or don't have life insurance at all. And why does the average American receive such poor returns long term on their investments. Some times it doesn't seem like the typical (conventional) financial advisor is doing such a great job. And more than likely Mr Katz serves the high net worth market and not so much regular folks. I may be wrong.

My advice to Mr Katz is that he read a couple books like Becoming Your Own Banker by Nelson Nash and Bank On Yourself by Pamela Yellen. I suggest Mr Katz meet personally with Nelson Nash or attend one of his seminars. I am confident Nelson Nash would love to me with Katz and discuss the matter. Nothing any of us on this forum can say will change the belief structure of Mr Katz regarding cash value life insurance. He will have to meet with the master, Nelson Nash, to learn the truth.

One parting thought. People don't save much for retirement because they owe too much...and always will. It's a life style most people have. The vast majority of financial advisors never address that or help their clients get out of debt and stay out of debt. But what if debt elimination and wealth creation went hand in hand using the same financial instrument (properly structured cash value life insurance). What if the average person can finance their OWN way through life while at the same time building wealth and retiring tax free....all with NO risk of losing their money. Wow, what a apparently Mr Katz knows nothing about.

I'm not a genius. I just listen to smarter people than me and learn a thing or too....and have an open mind to learn new things.

Victor Cuevas
17-Jan-2013 10:02 AM

At the risk of being repetitive, the above article is lacking in accuracy and misses the mark on its depiction of using life insurance as a retirement plan (LIRP). As the posts before mine have already stated, modern Universal and Whole Life products, and especially Indexed Universal Life products provide creative, efficient, and flexible retirement strategies for specific individuals. These are not your Grandfather's life products.

The industry has progressed in its offerings by necessity; and to the advantage of our clients. Not every strategy is appropriate for every client, and neither is every product. However, the Buy-Term-and-Invest-the-Rest (BTIR) strategy...on its widely viewed by professional advisers as not a good one. Sweeping statements, like the ones made in the article, ignore the basic foundation of our financial advisory/planning profession - find the best solutions for our client, utilizing the best options and strategies available for that specific client. Holding the position that permanent life insurance should not be used in retirement planning ignores tremendous opportunities from which a client might benefit.

I would be willing to go ledger-to-ledger with a properly over-funded IUL, against a BTIR strategy. Numbers do not lie. My website is and I welcome any and all comments!

19-Jan-2013 09:13 AM

I have read the above mentioned article several times and done several different illustration for whole life and term. Our whole life plans here in Canada offer 2 different plans. Without getting into a long drawn out discussion about dividend values, guarantees and cash values and buy term and invest the difference etc. The comments above responding to to the article hit the nail on head so to speak. These comments are based on US policies and while it is true that insurance whether it be US based or here in Canada should NOT be the main focal point of a business, family or individual complete retirement plan. It should however have a significant role in their plan to cover finanl expenses, income, education etc as it does enhance the estate value tax free and there is no taxe paid on the growth. It is also true the buy term and invest the difference does actuaaly cause the policy holder to use the difference between term and whole to invest in their retirement plan, not in my years as an a advisor anyways.
If anyone in Canada would like an illustration or like to know more about it. They can visit my LinkedIn profile and watch a video or see the PDF
on what whole offers either through a 20 pay plan (which is completely paid off in 20 years) or a Jubilee whole life plan.
Last comment: A complete financial plan should always be completed along with a full needs analysis to ensure proper financial planning.

20-Jan-2013 05:44 PM

Let's not forget the bigger picture. It has been reported that over 50% of American households are either uninsured or under-insured. If we as professionals can't agree on permanent, term, BTID, etc., is it any wonder that a premature death leaves many families financially devastated. Let's agree that we need to focus on educating Americans on the importance of income protection, debt management and wealth accumulation.

21-Jan-2013 12:58 PM

Jim Mescall • In my opinion Mr. Katz is what retirement planning and tax expert, Ed Slott CPA, would call "One of the many Financial Advisors out there that should be avoided". I would recommend Mr. Katz not only read Patrick Kelly's book but also read one or two of Ed Slott's books on the subject of retirement, taxes, income planning and legacy transfer. Obviously it has to be the correct type of Life Insurance product- Universal, Whole Life, or Indexed Universal Life. I would suggest Mr. Katz may also want to take some courses on risk management and tax planning. History is loaded with examples of wealthy and famous people who followed the "government plan", and had their estates wiped out. One famous individual was the financial titan of Wall Street, J P Morgan, himself. Even swivel hips Elvis’s estate was “all shook up”. Those who fail to study history are doomed to repeat it. I am grateful for advisors like Mr Katz and Susie ‘O”, because they are a great act to follow after their client presentations. Remember Susie ‘O’ lost her entire fortune before becoming a nationally acclaimed financial guru. Here is an example of the damage a financial advisor can do to peoples' retirement lives.Google my March 27, 2010 Suntimes, “whistleblower Mescall exposes Ponzi scheme-'Man smelled Ponzi scheme, but 'state wouldn't act' -
Mar 27, 2010 – Bernie Madoff had Harry Markopolos, the whistleblower whose warnings ... Mescall explained his suspicions in an e-mail to a state regulator

Jim Mescall
25-Jan-2013 10:33 AM

I could not disagree with this article more. He never mentions that when the money comes out in the 401k that it is fully tax. Taxes are going up with no end it sight to how high they will go. Another point is what happens when the companies 401k goes down in a bear market.

The bottom line is that the average 401k or IRA runs out of money in about 12 years because of inflation and taxes. With rising taxes they will run out of money even faster.

You must look at the effect that taxes will have on a retirement plan and when you do you will concluded that permanent life insurance is the hands down best vehicle for life insurance.

Add to that the new policies that offer critical and chronic illness protection and it is absolutely amazing what it will do for you.

Term policies are cheap because insurance companies very rarely pay out on one. you are not likely to die during the term. At the end of the term you may be too old or sick to buy a new policy and now you have nothing.

Let's look at the scale:
Permanent policy gives you protection from critical and chronic illness and death whenever they occur and protection from taxes.

Buy Term and invest the rest:
Temporary protection form death and critical illness, no protection from taxes, no protection from market swings.

People like the writer of the above article are not telling you the whole picture. They just want you to hear what serves their own agenda.

21-Oct-2014 11:15 PM

Good blog post ! i also ask some question about this topic !!Should life insurance be a key part of your retirement plan? Life insurance should be a vital part of your overall financial plan, specifically, if people depend on your income (e.g. your children and your spouse).

21-Jun-2016 01:12 PM

Hey, ask your financial advisor what the internal arbitrage strategy is when you start taking your 401k or mutual fund....hmmmmmm. Oh that's right, they don't have any. Also ask him how to have the money grow tax deferred and taken tax free...I hear crickets. Wait, let's look at the actual numbers....Now for all of you financial wizards masking yourselves as physicians, here's a bigger clue. These numbers include dividends and CAGR....Oh yes, you forgot to factor in sequence of returns...The market: 1995-2015 11.29% return but adding in sequencing, actual is 9.44 2000-2015 5.78 actual 4.02 2005-2015 8.75 actual 7.06 2010-2015 13.39 actual 12.93 Now, if this is qualified money, subtract a third for taxes. If this is a managed account, subtract at least 1% for who knows what. Actual IUL crediting rates: 1995-2015 7.83 2000-2015 6.36 2005-2015 8.04 2010-2015 8.14 Hmm, I hate it when actual facts get in the way of a good story. Oh, and in my IUL, I slept when everyone was freaking in 2000-2002 and 2007-2008 The only two guaranteed appreciable assets are life insurance and annuities...As Detroit about their municipal bonds and real estate "investors" in 2008...If you have a policy eating up your cash value, you had an agent making a play for commission. A properly designed insurance policy designed for growth will be designed under death benefit option B at the MEC limit. Now, I did stay at a Holiday Inn Express last night, but I don't think I'll be operating on anyone soon, however, if I need an operation I'm going to get it even though I don't understand it because I trust my doctor. Hey doc, sounds like you've been forced to learn something over your head because you've been set up by your present insurance advisor.

24-Jul-2016 01:29 AM

Life insurance is definitely a vital part of overall financial plan. Great article!

24-Aug-2016 12:42 PM

Life insurance has evolved. Today, indexed universal life insurance would be the product of choice to supplement a retirement plan. I agree that life insurance should not be the only piece of the retirement puzzle but an add-on. When structured and funded properly, one can create a tax-free income stream that is not subject to normal retirement plan rules and regulations. You can read more here -

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