It seems as if a day never passes when we don’t hear something about retirement planning. The media seem fixated on how ill-prepared we all are for retirement and the myriad things we can do to catch up. The many retirement product offerings in the marketplace can make even thinking about retirement planning a stressful exercise. However, retirement planning doesn’t need to be stressful. There are ways to plan tax-efficiently, which is increasingly important to our younger, successful clients.
To start, it helps to be realistic about the challenges of retirement planning. The unfortunate reality for many members of the younger generations (I am at the tail end of Generation X myself) is that few if any of us will receive pensions. Many of us have concerns about how much we will see in Social Security retirement benefits. In addition, as our younger clients’ and prospects’ incomes grow, the percentage they can contribute to their employer-sponsored retirement plans gets smaller and smaller. On top of that, as their incomes grow, they earn their way out of their next most tax-efficient retirement vehicle, a Roth IRA.
For example, let’s take a 35-year-old prospect who earns $300,000 a year in income. Their maximum possible 401(k) contribution for 2015 is $18,000, which amounts to 6 percent of their income. Every piece of literature they have read tells them to contribute to a Roth IRA. However, they now exceed the federal income limit of $116,000 for individuals and $183,000 for married couples in 2015, and they can no longer make contributions. A variety of reports on retirement savings inform our client they need to save anywhere from 15 to 25 percent of their income to retire comfortably. We cannot blame them if they feel they are facing an uphill battle.
What are the options for our clients?
Walk your clients through a process designed to examine a variety of options for their retirement savings, and discuss the advantages and disadvantages of each one. The first option to present is a nondeductible individual retirement account, which offers tax deferral. Next, review the pros and cons of annuities. Similar to a nondeductible IRA, an annuity gives the client tax-deferred accumulation. Clients do not have the same contribution limits with annuities that they face with an IRA. Withdrawals and/or distributions from the annuity may be subject to taxes in retirement.
Next, discuss tax attributes of cash-value life insurance, which, similar to annuities, does not have contribution limits like an IRA has. Policyholders are not subject to penalties if they access their cash values prior to age 59½, nor do they need to make required distributions at age 70½. In addition, if they structure the policy properly, clients can access their accumulated wealth on a tax-preferred basis through withdrawals and policy loans. Understanding cash-value life insurance — the protection component, its ability to meet retirement planning objectives tax efficiently and the opportunity to save even more money for retirement — is often a very positive revelation for clients.
After we show clients the power of tax-deferred, compounding interest, many quickly come to the conclusion a tax-deferred bucket is more effective than one taxed every year as the funds accumulate. Inform your clients this is not a “silver bullet” and is not the only place where they should be saving retirement dollars; however, it is a great complement to the planning they have already done.
This creates an outstanding opportunity for advisors with clients who have children in their prime earning years and are experiencing success or looking for new opportunities outside the traditional wealth transfer market. As younger, higher-income clients realize the gap they face in their retirement savings, life insurance can play an integral role. Life insurance not only solves a need to create an estate that has not yet had time to accumulate in the event of their untimely death, but it also assists in growing wealth to a point where they can retire comfortably.