Most people have two investment accounts:
(1) a traditional retirement account that uses pre-tax contributions, accumulates tax-deferred, and distributes payments fully taxable as ordinary income.
(2) a traditional investment account funded with after-tax contributions, accumulates with current taxation (1099s every January) and may be subject to capital gains when sold for retirement income.
The first works very well if every year of retirement one is in a lower income tax bracket than when the dollars were contributed. The second works very well if every year of retirement one takes distributions in an up market.
But, what happens if during some retirement years, an individual is in a higher income tax bracket and/or investment markets are down?
Using life insurance in retirement planning
Assume a hypothetical client is 35 years old with parents who are both age 60. How old will they be when the client retires? If the client retires at 65, they will be 90 or already gone.
What if the client were to purchase individual or survivorship life insurance on the parents using a portion of his or her retirement planning budget? They may not be gone when the client retires. But if not, they certainly will die during the client's retirement.
Just look at the internal rate of return on premium to death benefit.
If they die before actuarial life expectancy, then the client's return is like winning the lottery (lousy lottery to win, as the parents died early).
If they die during actuarial life expectancy, then the client's return is like that of the stock market, usually between 5 and 9 percent. (Remember: the death benefit is tax-free, but funded with after-tax dollars.)
If they die after actuarial life expectancy, then the return is like that of a bond, usually between 2 and 5 percent (but again, tax-free).
But, who wants to talk to their parents about insuring their lives? Sounds quite morbid, doesn't it? That's what every child says, but every parent says, "Why not, if it doesn't cost me anything. And, while you're at it, tell your brother and sister about the idea."
Take that same 35 year old. Will he or she likely be in a higher income tax bracket at retirement or a lower income tax bracket than he or she is in now? If upwardly mobile, then why focus all of his or her retirement savings on pre-tax contributions?
Instead, consider setting aside at least a portion of the retirement savings budget with after-tax contributions that accumulate tax-deferred and are distributed tax-free in Roth IRAs, if within the income limits. Phase-out in 2014 occurs between:
