By Peter Mastrantuono
Sustaining retirement income over decades is the biggest financial challenge most Americans will ever face. It requires smart, long-term planning, maximizing income generating and capital growth opportunities and making sure that no option goes unconsidered.
One potentially valuable source of retirement income comes from one of the least likely of places—life insurance. Many retirees and near-retirees own life policies on which they may still be paying annual premiums for financial protection they no longer need. What many fail to recognize, however, is that their life insurance policy has become a “stealth” asset—an asset that can help fund their retirement.
Converting Life Insurance to Retirement Savings
Individuals who have current life insurance coverage may be able to convert the value of that policy through what is known as a life settlement, in which a purchaser buys an individual’s life policy for an agreed upon amount in exchange for ownership, assuming all future premium payment responsibilities and receiving the death benefits when the insured dies.
(Life settlements are different than viatical settlements, which represent the sale of an existing life insurance policy at a discount by individuals who have a life expectancy of generally under four years due to illness.)
Here’s an example of how a life settlement works:
Thomas, age 67, owns a life insurance policy with a death benefit of $500,000 and a cash value of $150,000. He currently pays an annual premium of $3,500. If he chooses to sell his policy to a life settlement investor, he would receive an amount between the cash value and the death benefit. The amount that Thomas receives would be based on a number of factors, including his health and life expectancy.
Thomas would receive a lump sum from the sale, which he could elect to invest or spend to meet his retirement needs. Additionally, he would also eliminate the expense of future premium payments, though he forfeits the ability to leave the death benefit proceeds to family or charitable beneficiaries.
Life settlements are not appropriate for everyone or in all cases. They should only be considered in instances where coverage is no longer required, premium payments are no longer affordable, the insured has no beneficiaries or there is a need to supplement retirement income or pay for long-term care expenses.
A life settlement is not the only way to access a life insurance policy’s cash value. An alternative option is to borrow against the cash value, though there are drawbacks to this approach, including incurring interest charges, which if left to accumulate for too long could have taxable consequences. Nevertheless, it is an approach that preserves the ability to pass the death benefit to beneficiaries.
Not all life settlements are created equal. For instance, the carrier of a life policy typically offers substantially lower settlement amounts than third party life settlement providers. Consequently, individuals should work with a financial advisor who can help determine whether a life settlement makes sense and evaluate the competing offers.
Peter Mastrantuono is a contributing writer to www.myperfectfinancialadvisor.com, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.