What if there were a way for you to avoid paying taxes in retirement? That’s the promise offered by a life insurance retirement plan.
Read on to learn what money expert Clark Howard thinks about this somewhat controversial financial tool.
Life insurance retirement plans: Look before you leap
One of our readers named Hank wrote in to Ask Clark with the following question:
“My wife and I recently signed up for a retirement planning class. This class was based upon the book ‘The Power of Zero.’ The hope is to spread your retirement funds into three different buckets so you will avoid paying income taxes in retirement. They are pushing us to purchase a LIRP. What can you explain about this book and are LIRPs a good tool to utilize?”
OK, let’s take a step back: What exactly are life insurance retirement plans, or LIRP?
According to U.S. News and World Report, LIRPs are a kind of whole or universal life insurance policy that is marketed as being great because there’s no income limit to do one, you can make unlimited annual contributions, there are no penalties on early withdrawals and you pay no annual tax on investment gains.
But the downside is that LIRPs tend to be padded with massive commissions for the people who sell them. And as a general rule, LIRPs usually make the most sense for people who earn more than $350,000 per year because of the supposed tax benefit they offer for folks in higher income brackets.
What’s Clark’s take on universal life?
Clark Howard has long said any insurance that has the word “universal” in it is radioactive for your wallet.
As mentioned before, these plans have huge commissions for the agents that sell them. But the worst part is that these policies have enormous ongoing fees and often run out of money.
If you can’t meet what’s called a “capital call,” where you have to come up with extra money, the account that you poured all this money into gets wiped out and then you have a giant tax liability on your hands.
With variable or indexed universal life, you’re promised — in mind-numbing language going on for page after page — that you get a magic policy that’s a savings account, an investment account and an insurance account all in one.
The policy illustrations show that you will pay premiums for some time and then magically the policy will take care of itself. But in practice, it hasn’t worked out that way.
In one case, The Los Angeles Times reported that a customer who was paying $25 a month for life insurance over the course of 23 years got a notice that his premium was going to $510 each month! If he didn’t pay, he would lose everything he’d paid over the years and there would be no death benefit for his wife when he died.
With level-term life insurance, you just get a simple product that pays a death benefit if you die while the policy is in force, and the price you pay never goes up. Furthermore, there’s no investment or savings component at all to complicate things.
Having said that, a couple of other potential red flags jump out right off the bat from reading Hank’s email to us…
There’s no free lunch in retirement planning
First off, that part about signing up for a retirement class. While it’s great to broaden your understanding about retirement planning, a class may not be the best venue for that.
Why not? Simply because it’s hard to know if a class is straight-up legitimate or if there’s a hidden agenda where you’re going to be sold a product or service.
Unfortunately, it’s often the latter — as in, “They are pushing us to purchase a LIRP.”
So remember this: If you’re attending a seminar/class — particularly if you’re lured in with the promise of a free lunch or dinner — beware of buying a questionable fee-heavy investment from the facilitators.
That could well be the most expensive “free” meal you’ve ever had!
Try a roboadvisor if you’re younger and just getting started
When you’re looking for guidance on how to create future wealth, Clark has a kind of one-two punch he likes for you to do based on where you are in life.
Particularly if you’re younger, he recommends that you consider working with a roboadvisory firm. Roboadvisors leverage the latest in artificial intelligence and algorithm-driven portfolio management to deliver solid returns on your money, coupled with low fees.
You can see just how the low fees are from the leading roboadvisors here.
Generally, roboadvisors tend to appeal to millennials and those under 40 who are used to doing things without needing to actually sit down face-to-face with someone.
Fee-only financial planners can help fill in the gap the older you get
If you’re well into middle age, chances are a roboadvisor may not be your speed!
You’re in an entirely different boat: You’ve built up substantial assets and you’re approaching retirement. In your case, there’s no substitute for sitting down with a well-trained and educated human being like a fee-only financial planner.
A fee-only financial planner can provide invaluable guidance for when you’ve amassed a sizeable portfolio and it’s getting closer to when you’re going to spend it.
Notice we didn’t say a word about the book The Power of Zero or the specific zero-tax strategy it advises.
That’s because the purpose of everything Clark does is to empower you with the knowledge to make an informed judgment about the merits of the book and whether it would or wouldn’t work for you individual situation.
If you’re interested in the specifics of the Power of Zero strategy, see this thread on investment chat board Bogleheads. Many of the posters note the book is predicated on creating fear about tax rates in the future and offering a high-priced “solution” to that problem.
Clark, on the other hand, is an optimist by nature. His approach is more a “stay-the-course” style of investing rather than someone who pushes fear and products that he’s selling.
But the consumer champ has long said he’s just one man with one point of view. Whether you choose to follow his advice or not is up to you.
“There’s no one right strategy to create long-term wealth or financial security. But there are combinations of strategies that create opportunity, real estate among them,” Clark notes.
“And then there’s my belief that if you are well diversified and put money in the stock market each and every month, you have the opportunity to benefit over years from people’s fears about being in the game.”