The life contingency annuity is, as we have said in previous articles, central to effective retirement planning, because it can provide income that cannot be outlived.
But life contingency annuities are only one element of an effective retirement plan. Another effective tool is life insurance. We prefer variable universal life insurance because clients can use this insurance to supplement their annuity, pension and social security income. This article will explore how this works.
Most retirement plans have a built-in assumption that income tax brackets will be substantially lower after retirement than before. Naturally, everyone hopes that will not come true–most of us would prefer to continue maximizing our income after retirement.
Regardless of the retirement planning assumptions, however, taxes will continue to be a factor for most retirees. Fortunately, life insurance may provide a continuing tax benefit that can help ease the burden in the retirement years.
As you know, annuity distributions are subject to a formula that determines how much of each annuity payment is taxable and how much is not. This "exclusion ratio" is established at the time of receipt of the first annuity payment, and it continues for the life of the contract or until the owners entire basis in the contract has been recovered. In most instances, the bulk of each payment will be taxable at ordinary income tax rates.
If the retirees income tax bracket is, in fact, lower than it was during the working years, this tax bite may not be a serious factor. However, if the income remains at relatively high levels, additional sources of tax-free income may be necessary. This is where life insurance comes in.
Life insurance that qualifies as a "non modified endowment contract" permits the policy owner to borrow against the life policys cash values without having to pay income taxes, so long as the policy stays in force. As a result, cash value life policies (particularly variable life policies that have performed well over the years) can provide a source of valuable tax-free funds to supplement other types of retirement income.
This suggests that, when approaching retirement, owners of such insurance would do well to review their life policy cash values. Then, they should obtain illustrations from the insurer or agent that demonstrate various possible levels of annual or periodic borrowings they can make over their remaining life expectancy.
However, remember that policies can vary in their policy loan provisions. Most cash value life policies, for instance, do permit loans of all or a large portion of the cash value. But VL policies typically limit the total loan amount to some percentage of total cash value at any time.
