You are on page 1of 10

327

P R O C E E D I N G S
I
n these turbulent financial times, the thought of re-
tirement can be a scary thing. While our clients have
learned a great deal in the past few decades about in-
vesting and the market, they have also learned a few les-
sons about risk and loss. Often, these latter lessons have
been learned the hard way as clients have lost substantial
percentages of the wealth they worked for years to build.
For those who are younger, there’s still time to recover
from the losses, stay in the game, and rebuild lost wealth.
But for those who are at or near retirement or, worse yet,
already deep into retirement, the results of failed markets
and investment strategies have been overwhelming and di-
sastrous. Many feel they have no hope but to dramatically
alter their lifestyles, go back to work (if they can get it), or
plan on dying soon. It’s not that they failed to plan. Tey
did exactly what the industry, the media, and the financial
entertainers told them to do. So what went wrong, and is
there any way to make things better without taking even
more risk to try to recover?
Problems
Financial Planning Based upon Rate of Return
It is a fact that most of the work that is done in the
financial planning industry is based upon interest rates.
Interest rates are applied to current salary levels to deter-
mine an expectation of future earnings at the time of re-
tirement. Inflation rates are often used to estimate our fu-
ture cost of living. Inflation rates are also used to estimate
the expected rate of increase our clients will need during
retirement in order to keep their standard of living consis-
tent through those years. Rate of return is used to estimate
how much money our clients will need to accumulate in
order to fund that retirement cash flow. We apply those in-
terest rates to the funds they have already accumulated in
order to project their future value, and we use those rates
of return to determine how much more money needs to be
invested each year in order to bridge the gap between ex-
pected and needed cash amounts at retirement and other
important events, such as education of our children. And
Why Your Clients Need Value Replacement
Strategies Now
Robert C. Kievit, CLU, LUTCF
Robert C. Kievit, CLU, LUTCF, is a 30-year
veteran of the financial services industry, and
serves as senior vice president at National Financial
Network LLC. He has a long-standing reputation
within the industry as both a successful producer
and a high-level development specialist, helping
experienced and inexperienced producers to
organize, systematize, professionalize and grow their
operations. Before leaving personal production in
2003, Kievit was an MDRT member who achieved
Court of the Table status. He is a frequent guest
speaker at Guardian’s training programs for new
agents and new managers, as well as at various
field offices and industry association events. Kievit
is a charter member of GAMA International and
a recipient of its Platinum Career Development
Award.
National Financial Network LLC
7 Hanover Square, 8-A
New York, NY 10004
Phone: 973.216.9700
E-mail: robert_kievit@glic.com
MP3: MP1053 CD: C1053
328
P R O C E E D I N G S
Why Your Clients Need Value Replacement
Strategies Now  (continued)
more often than not, the targets we set are based upon
needs rather than wants and desires.
In reality, the setting of financial targets is a guessing
game at best. Sure, we can use our inflation, tax, and inter-
est rate assumptions to predict future needs or goals, but
there are many more variables that affect our future cost
of living besides mere inflation. Te fact is that needs and
goals are a moving target, partly because we have a ten-
dency to change them as we get closer to them, and partly
because other, less predictable factors drive our future cost
of living to levels that far surpass inflation calculations.
New inventions and technologies, items that need repair
or replacement, increased standards of living, rising tax
rates and new forms of taxes, and unexpected life events
all contribute to ever-changing needs and goals.
In order to be as accurate as possible in our projec-
tions, we rely on historical performance and averages,
which we then apply to our clients’ financial condition.
Unfortunately, we have come to realize that these averages
really don’t apply to our clients to the degree that we once
believed they did. Te simple reality is that no one really
achieves the averages because those averages don’t apply to
each individual in the same way. Te inflation rates that
our government provides us with are based upon a spe-
cific market basket of goods, which not all of our clients
participate fully in. Tere are many other products and
services they purchase that have varying degrees of infla-
tion impact, and they buy them in different amounts, so
inflation affects everyone differently. In addition, inflation
is not the only factor that affects our standard of living.
Tere are many other factors that will have a combined
impact of increasing our clients’ future cost of living way
beyond that which inflation rates would have us calculate.
Average rates of return are not much better. Tey are typi-
cally calculated by comparing the value of a particular in-
vestment type at the beginning and end of a specific period
of time and determining the consistent return that would
have been required to obtain that growth. However, we
all know that the market doesn’t work on consistent rates
of return. It goes up and down constantly and irregularly,
and the type of investment will impact the frequency, vari-
ability, and extent of those fluctuations—none of which
can be accurately predicted. Te timing and amount of
both deposits into and withdrawals from a particular in-
vestment will dramatically affect the actual rate of return
as compared to the average. While not necessarily a huge
problem for the accumulator of wealth, this impact can
be devastating for those in the distribution phase of their
lives.
Accumulating vs. Distributing
When a client is accumulating wealth for some future
event such as retirement, and he or she has a long time
horizon to get there, fluctuations in the market are not of
great concern for many reasons, but most notably these
two. First, when the market goes down it is likely that the
individual will have the ability to leave the money there.
Te belief is that what goes down must come up as it al-
ways has in the past. It may happen quickly or slowly, but
sooner or later the market has always come back from a
market correction. If our client leaves the money in the
market during and after a market correction, the money
lost in that correction will typically return when the mar-
ket goes back up. Te second reason is that, assuming the
client is continuing to contribute to his or her account, the
client has the ability to take advantage of dollar cost aver-
aging, which can positively affect long-term accumulation.
However, the same is not true for the client who is
in the distribution phase of life. Tese clients are often
attempting to live off the interest of their accumulated
wealth during retirement. When a market correction oc-
curs and these clients have money in the market, their ac-
count values fall. Even conservatively managed portfolios
are not immune in major corrections as we saw recently in
2008. For the most part, anyone who had money in the
market that year—conservative or not—lost some of it. In
fact, much of the money that was lost in 2008 will not be
coming back, regardless of where the market goes. Major
corporations closed their doors forever, and billions of dol-
lars were permanently lost to investment frauds, such as
329
P R O C E E D I N G S
Why Your Clients Need Value Replacement
Strategies Now  (continued)
those perpetrated by the likes of Bernie Madoff. For those
in the distribution phase who truly lost investments that
aren’t ever coming back, there is no recovery and little or
no opportunity to re-create those dollars through gainful
employment. But the big threat to those who simply saw
their investment account values fall during that correc-
tion is that they often don’t receive the same level of in-
come—if they receive any at all—from their investments
in such a market downturn. As a result, because their
living expenses typically don’t go away just because some
of their money did during these time periods, they must
draw down some of their principal in order to live and pay
their monthly bills. If and when the market does rebound,
they don’t have as much money in it. Tey felt the full
impact of the downturn, but only get part of the benefit
of the recovery. Each time this happens, these clients see
more and more of their retirement wealth stripped away.
Compounding this problem is the fact that their remain-
ing dollars are now called upon to create the same level
of income their previous balances were providing, often
causing people to look for ways to increase the rate of re-
turn on their money. Generally speaking, the greater the
pressure we put on our assets to perform, the greater the
chance, and even the probability, of failure.
Pressure on Assets to Perform
As a result of our dependence on rates of return, we
find ourselves putting pressure on assets to perform in or-
der to reach our goals. Te calculations tell us how much
we’ll need, how much we’ll have, how much more to put
away, and what rate of return we need to get on it all to
take us to the promised land. And so we put our assets in
the market and try to look for the best investments we can
find, often with the focus on highest rate of return within
tolerable levels of risk.
Along the way toward our objectives, we have these
occasional checkpoints where we take a look to see how
we’re doing. Unfortunately, because the target moves and
market corrections occasionally diminish the value of our
investments, we often find that we’re not on pace for our
objectives. So we put a little more pressure on our assets to
get a little better performance. After all, we’re smarter now
and have more investment experience and perhaps a better
investment advisor than before. But the more pressure we
put on our assets to perform, the greater the probability
of failure.
Lost Money
In the first quarter of 2001, many of our clients who
were working hard and investing hard as they prepared
for those glory years of retirement got a major shock and
a major setback as the tech bubble burst and the market
came tumbling down. Entire lifetimes of blood, sweat,
and tears in the form of retirement nest eggs got slammed
by double digit losses in the market. Te lucky ones lost
10% to 20% of their wealth, while others lost more—
sometimes a lot more. 401(k)s became 201(k)s and many
investors were paralyzed, not knowing whether to get out
and take the loss or stay in and ride the market back up
again. Ten, just about seven months later, the unthink-
able happened—9/11—and the market tumbled again. It
took years for people to regain the financial ground they
lost in 2001, and many still hadn’t recovered when the
bottom dropped out of the market again in 2008. Again,
when you’re 30 years old and the market drops, you’ve got
time to build it back up, but not so if you’re at or close to
retirement. Our younger clients usually get upset by the
market downturn and the reduced balances on their state-
ments and necessarily worried. But for our over-50 clients,
there’s a different sense of concern. Tose clients see these
reduced balances and grow concerned about whether or
not there will be time for the market to bring their money
back before retirement. Tey know the only way they’ll
get it back is to leave it in the market, but they’re growing
more and more uncomfortable with the market. What if
another downturn occurs between now and retirement?
Te time horizon to recover from the next market cor-
rection will be even shorter. Tese folks have competing
fears—fear of what the market may do to what’s left of
their wealth and fear of whether or not they can grow
330
P R O C E E D I N G S
Why Your Clients Need Value Replacement
Strategies Now  (continued)
enough wealth to retire if their money is not in the mar-
ket. At the same time, they keep looking at all the money
they lost in the market and wondering how they can get
it back.
Solutions
Replacing the Value instead of the Wealth
While we can’t replace the money they lost in the mar-
ket in 2001, 2008, or any other market downturn for that
matter, we can often replace the value of those lost dollars
by strategically managing wealth to reproduce the income
those assets would have created had they not been lost in
the market. In other words, we can often help clients to
have the same or even greater income from their assets
than they would have had if they had not suffered a loss
in asset value in the market. Tis is not about finding a
better investment sector in the market. It’s about helping
clients to strategically align their financial products in
a way that allows them to draw the highest possible net
after-tax income from their wealth while actually reducing
risk, therefore increasing the probability of success.
Grow Wealth through Strategy, Not Product
During whatever remains of their accumulation pe-
riod, we can help our clients focus on efficient deployment
of cash flows so we keep more of their money on their bal-
ance sheet as opposed to allowing unnecessary taxes and
other expenses drain dollars off the balance sheet. Having
more wealth on the balance sheet helps reduce the pressure
on those assets to perform at high rates of return, which in
turn decreases the risk necessary to obtain those returns,
therefore increasing the probability of success.
Once they reach retirement, we can create more effi-
cient distribution options that provide greater cash flow
from their assets. By focusing on strategic uses of finan-
cial products, most notably permanent life insurance, we
can give our clients greater choice in the way they access
their retirement wealth. Different retirement distribution
strategies provide different levels of gross income, different
levels of tax (hence, different net incomes), different levels
of endurance and guarantees, and different levels of legacy
for survivors. Some options create substantially better re-
sults for clients than others. However, not all options are
available to all clients.
Most Americans arrive at retirement with only one re-
tirement distribution option—invest their money and live
off the interest it produces. Te problem is that if they
begin to dip into principal, they run the risk of running
out of money before they die. Since they don’t know when
they’re going to die, amortizing their wealth by tasking
principal and interest is not usually an option. Tat only
works if they die on time or even sooner. Predicting date
of death is no easy task. Traditional tables of life expectan-
cy ignore the current health status of our clients as well as
their financial standing, which can influence the level of
care they’ll receive if they get sick. In addition, most focus
on individual mortality statistics, whereas in most cases
we really need to consider joint mortality figures because
we need retirement income to continue until the second
death. Tese mortality statistics show that the retirement
funds may have to last for a very long time. In addition,
clients may want or need to leave behind legacy after death,
at the very least for a surviving spouse, but often for others
such as children, other heirs, or charity. So they try to find
a safe place to invest that will provide enough income for
them to live in a way that is acceptable in retirement. Most
often, because they have not saved enough to accomplish
this objective at low rates of return, they are forced to be in
the market in conservative portfolios. Unfortunately, even
conservative portfolios that are invested in the market are
susceptible to loss during market corrections, and these
people often find their retirement nest egg diminishing
over time.
Tis retirement distribution option, which we’ll call
“Option 1,” requires the largest accumulation of wealth
of all distribution options in order to provide a specific
level of retirement income. It also provides the lowest gross
income, the highest tax, and therefore the absolute lowest
net income of all retirement distribution strategies. Yet, as
bad as it is, it is the only option available to most people
331
P R O C E E D I N G S
Why Your Clients Need Value Replacement
Strategies Now  (continued)
out there because no one ever showed them how to posi-
tion their assets for retirement in a way that would allow
for other strategies to be used. Simply put, the bar that
most Americans must reach in order to give them the net
after-tax income they need is far too high for them ever to
reach. Yet they put more and more pressure on their assets
in an effort to get as close as they can.
Providing our clients with other, more efficient retire-
ment cash flow options lowers that bar of required accu-
mulation—sometimes quite substantially. If we can show
our clients how to access their wealth using other forms of
distribution that provide greater income from a set level
of wealth, then we can dramatically lower the amount of
wealth necessary to provide retirement income. In turn,
this relieves the pressure our clients must place on their
assets to perform, thereby increasing the probability of
success. Having multiple retirement distribution options
provides for a greater level of retirement cash flow flex-
ibility. And, properly structured, we can actually show our
clients how to end up with more wealth, better protection
of that wealth, less risk, and greater net after-tax income
in retirement.
Process
In order for clients to fully understand the value of
these improved strategies, as well as the products and po-
sitioning involved in making it all work, there are a num-
ber of concepts they need to understand first. Building
this foundation of knowledge is critical to your success in
helping your clients implement these strategies. Showing
the strategy first and then trying to explain why it works
will rarely result in a positive outcome, as clients will re-
sist the solution if they don’t understand these underlying
concepts.
Living off the Interest
First, let’s examine the process and impact of living off
the interest provided by our investments. Clearly, it will
make sense to invest conservatively during retirement in
order to avoid the pitfalls of market corrections and other
disasters that can occur when money is invested more ag-
gressively. In our example, you’ll see that our clients who
are in a 35% marginal tax bracket with $1,000,000 invest-
ed at 5% will receive an annual gross income of $50,000
from that particular bucket of money. Our couple will
pay $17,500 of that in taxes for a net after-tax income of
$32,500. Again, they’re forced to use this option because
they are afraid to dip into principal for fear of running out
of cash before they run out of breath. Tey also want to be
sure that the survivor of the two will still have money to
live on, and they would like to leave behind some legacy
for their children.
Amortization
Another retirement distribution option would be to
amortize this $1,000,000 asset over a period of time,
let’s say 20 years. In this situation we can derive a much
greater gross income because we are taking both principal
and interest, giving our couple a gross annual income of
$80,243. Tat’s an increase of more than $30,000 in gross
income compared to living off the interest. In year one,
the tax is the same—$17,500—because the interest that
year is the same and we only pay tax on the interest, not
the principal, assuming this is not tax-qualified money.
Tis leaves us with a net after-tax income in year one of
$62,743—an increase of over 93%! Furthermore, while
our gross income stays the same each year, the portion that
is principal gets larger and the portion that is interest gets
smaller, creating an ever-declining tax bill. As a result, our
net after-tax income actually goes up each and every year
to $78,906 in year 20—an increase of more than 142%!
Total gross income for the 20-year period from interest
only is $1,000,000 with $350,000 in tax for a total cumu-
lative net income of only $650,000. For the same 20-year
period, the amortization strategy delivers a gross income
of $1.6 million—more than 60% more—while actually
reducing the income tax burden to $211,696, for a net in-
come of more than $1.3 million—more than double that
provided by the interest-only strategy. Tat’s an amaz-
ing result for the first 20 years, but we have two major
332
P R O C E E D I N G S
Why Your Clients Need Value Replacement
Strategies Now  (continued)
problems. First, the legacy value for the surviving spouse
or other heirs is constantly declining. Second, the income,
the asset, and the legacy value are all gone at the end of the
20-year period. While the dramatically enhanced retire-
ment income stream provided by amortization is certainly
enticing, our clients are very unlikely to utilize it because
they simply aren’t willing to take the chance that they will
live longer than 20 years, disinherit their heirs, or both.
It’s a great option; it’s just not an option for them.
Annuitization
Another retirement distribution strategy that can pro-
vide a substantial increase in retirement cash flow is asset
annuitization. Annuitization is essentially an exchange
of assets for income. Te insurance company that issues
the annuity estimates the client’s life expectancy and then
amortizes the asset over the number of years between the
annuitization date and the client’s life expectancy. Since
estimated life expectancy gets shorter as we get older, this
can create a more rapid amortization period. In addition,
the application of the exclusion ratio causes taxes in the
early years to be significantly lower than a regular amorti-
zation. Te annuity also includes an added feature that re-
quires the insurance company to continue payments to the
client even after the funds have been exhausted, thereby
eliminating concern over outliving the money. In this way,
a client can enjoy both principal and interest consumption
with additional up-front tax benefits without the fear of
ever running out of money. In our example, you can see
that for a male client aged 70, the $1 million exchanged
for an immediate annuity would produce a gross income
of $89,027, which for the first 15 years would be subject
to only $8,579 of tax, providing a net after-tax income
of $80,448—an increase of more than 147% over living
off the interest. After 15 years, the taxes go up, leaving a
net income of $57,868, but this is still 78% better than
interest-only. However, the reason the insurance company
is willing to do this is they know that some of their an-
nuitants will die before life expectancy, and in those cases
the insurance company keeps any unused assets. Tat
represents a substantial risk to a couple who is trying to
make the money last both their lifetimes with a legacy
for heirs. If the annuitant is the second of the couple to
die, then income is secure for the couple’s lifetime, but
no legacy will exist for heirs. Worse, if the annuitant dies
first, then the spouse will have lost the income-producing
property and the income. Tere are options available in
annuities to provide income for both lives (joint and sur-
vivor options) and to provide some legacy for some period
of time after annuitization (period certain options), but
each of these options reduces the income that would oth-
erwise have been provided in a single life straight annuity.
Needless to say, while this is a great option for maximiz-
ing income during retirement, it’s just too risky for most
couples to consider.
Market Corrections and Risk
While other such options for increasing net retirement
cash flow exist, we will limit ourselves to those presented
above for this discussion. However, suffice it to say that all
of them have negative aspects that typically prevent clients
from actually utilizing them. As a result, as mentioned
previously, most people resign themselves to investing in
the market and trying to live off their returns. But mar-
ket corrections do happen, and money in the market has
risk that goes beyond mere interest rate risk. It bears the
risk of loss to principal. As discussed earlier, the impact of
these corrections on someone who is accumulating wealth
is very different than that on someone who is in the distri-
bution phase of life. In this example, we can see how the
same ups and downs of the market create very different
yields based upon the addition to or withdrawal from the
market. As you can see, taking a fixed withdrawal, such as
that which would be required to support a consistent life-
style, from a variable account can be a recipe for disaster.
Even market corrections that occur shortly before retire-
ment can be devastating because we may not have time to
regain lost ground before retirement distribution begins.
Once our clients understand these facts that affect their
retirement situation, it is time to start asking them a series
333
P R O C E E D I N G S
Why Your Clients Need Value Replacement
Strategies Now  (continued)
of pointed questions that will help them see the value from
a wider angle of a better retirement strategy.
Question #1: How often do market corrections
occur?
Tis is a great question to ask of your clients because,
while there are a lot of opinions on this, there really is
no right answer. Tis is partly because there are so many
interpretations of what a market correction actually is, but
even more so because while we all know they do occur, we
also know that market corrections do not occur at regular
intervals. In fact, they probably happen more often than
most people remember because we have a tendency to have
short memories of loss once the market starts going again.
As you can see from the chart on the screen, the stock
market has many ups and downs, and they certainly don’t
appear at any clearly predictable intervals. [visual]
Question #2: When is the next one scheduled for?
Tis question usually gets a chuckle from clients be-
cause they recognize that if any of us really knew the
answer to that question we could all be rich. Te fact of
the matter is that we really don’t know when it will hap-
pen next. If we listen to the radio, read the magazines
and newspapers, watch TV, or pay attention to any other
source of predictions, the only thing consistent about the
predictions is their relative inconsistency. For every finan-
cial pundit who warns that a correction is coming soon,
there are others who claim this is the best time to be in
the market. Te point we’re trying to bring home to the
client here is that there is another one coming and it could
be far off in the distance or just around the corner. We
simply don’t know for sure which it is. For those at or close
to retirement, there is another part to this discussion that
clients need to understand. Earlier, we had a discussion
with our clients about life expectancy, and now would be
a good time to show them exactly what that looks like. Te
chart shown here is based upon a specific carrier’s actual
mortality experience based upon insured lives rather than
those that are based upon the general population. If we
look at a 55-year-old couple, the probability is that the
husband will die first, and he reaches a 50% probability of
death at around age 85. His wife doesn’t reach that same
50% probability line until closer to age 88. However,
when we look at combined mortality, we don’t reach a
50% probability of the second death until age 92. Tat’s
about a 37-year time horizon. Considering the frequency
of market corrections, and the probable longevity of our
couple, now would be a great time to introduce the next
question.
Question #3: How many market corrections are
likely to occur during retirement?
With both the market volatility chart and the life ex-
pectancy chart fresh in our clients’ mind, they are begin-
ning to see the picture much more clearly. While nobody
can accurately predict how many corrections they will see
or when they will occur, there is little doubt that they will
see several during their remaining years, and each time
it happens they are likely to lose some ground in their
accumulated wealth. In fact, there’s a pretty fair chance
that unless they are endowed with truly abundant wealth,
they may see their assets whittled away each time there’s
a correction, forcing them to use more and more of their
principal to live on, until one day, there simply isn’t any-
thing left.
Question #4: How much of your money do you
want in the market when the next correction occurs?
Te most common answer we get to this question is
“none.” Given the choice, none of us really want to have
our money in the market when the next correction hap-
pens because we know that it will mean the loss of some
of our wealth. While this is an easy question for people to
answer, it sets up the dilemma that they all face. How can
we get the returns we need from the market to provide us
with the income we need without having to worry about
losing a chunk of our money when the next correction
happens? While it would be nice to say that we didn’t
get hit by the market correction right after it happened,
334
P R O C E E D I N G S
Why Your Clients Need Value Replacement
Strategies Now  (continued)
having no money in the market is probably not feasible for
most clients. Of course, if they tell us they want it all out
of the market, we would be compelled to do as they ask,
but we must also point out the fact that this action would
probably cause what we call an unconscious depletion of
wealth. Tis is due to the fact that assets invested in a way
that is completely safe from market loss is not likely to earn
returns high enough to offset the effects of inflation, much
less all of the other cost of living factors discussed earlier.
Terefore, it is nearly a necessity for most of our clients to
have at least some of their money in the market in order to
capture the higher rates of return that are available in the
market as opposed to those available out of it. At the same
time, it is wise for clients to have the rest of their wealth
out of the market so that it is out of harm’s way when the
next correction occurs. Our experience is that clients are
very much in favor of this since it adds great comfort to
their situation, provided they can get enough income to
live on. Te idea of having the income they want with
substantially less risk is extremely appealing to them, and
for obvious reasons.
Question #5: What rate of return would you
reasonably expect to receive on those assets that are
out of the market?
By “money out of the market” we mean that the mon-
ey is invested in a way that when the market goes up the
money goes up, and when the market goes down the money
still goes up. In other words, these are non-correlated assets
that are not at risk of loss due to changes in the market or
the economy. Clearly, we can’t expect high rates of return
on this kind of money. In fact, the choices are few, such
as certificates of deposit, money market accounts, and sav-
ings accounts. When we ask this question, most clients will
come back with an answer of 2% or 3% for a reasonable
rate of return. But of course, rate of return is not the only
characteristic that must be considered when comparing
investments. Tax treatment is also important. Obviously,
an investment that grows on a taxable basis will not be as
favorable as one that grows tax free. Even if the taxable
product has a higher rate of return, it may not be as valuable
to the client as the lower return product that grows tax free.
Market risk and volatility are also important features to
consider, although here we are trying to look at assets that
have neither of these characteristics. Liquidity is another
aspect that must be considered. Liquidity is important be-
cause it considers the relative accessibility of our wealth. It
is important that our clients maintain sufficient levels of li-
quidity throughout their lives, but it is increasingly impor-
tant during retirement because we are more likely to access
our assets during retirement than we are during accumula-
tion. Creditor protection is also an increasingly important
factor, as money lost to creditors will be more difficult, if
not impossible, to replace during retirement years.
PLI as a Solution
So let’s consider another asset class that fits well into
our “out of the market” classification. It’s called perma-
nent life insurance, otherwise known as plain old vanilla
whole life insurance. Not variable, not universal, not whis-
tles or bells, just good old-fashioned life insurance—the
kind we used to sell back in the days before our industry
started developing all these newer, fancier breeds with
more opportunity for growth, more flexibility, and many
of the risks that come with that. Te cash values that grow
inside of whole life are guaranteed against market loss and
have guaranteed growth rates that are printed right in the
policy. Once a dollar is credited to cash value, it cannot
ever be worth less than a dollar. Even the dividends paid
by mutual insurance companies, while not guaranteed to
be paid, once paid can become part of policy cash values
and are not subject to downward fluctuation in value. For
the moment, let’s just think about this policy as an asset
accumulation vehicle, a product for building money like
any of the other “out of the market” savings vehicles we’ve
discussed. Let’s temporarily ignore the insurance aspect.
Suppose we could find an asset in this class that could give
us a rate of return over time that exceeds the 2% or 3% we
would expect. Suppose it was more like 4% or even 5%.
Tat might be a better place for the money, but we’d have
335
P R O C E E D I N G S
Why Your Clients Need Value Replacement
Strategies Now  (continued)
to also look at the other attributes as well. How about if
we could get this higher return and have it accumulate
on a tax-deferred basis, with the ability to access it as if it
were tax free. Tat would be even better. Furthermore, in
most states this asset is protected against creditors as well.
Tere’s no market risk on the downside, and if written
with a mutual company, there’s even some upside poten-
tial due to increases in future dividends. Tere is some
limited liquidity in the early years, so we need to be care-
ful not to move too much money there too soon. We also
run the risk of sacrificing some of the tax benefits if we
move too much too fast. Instead, assets shifted to life in-
surance should be moved gradually over time, typically 10
or 15 years, and perhaps longer.
Take a look at this example in which we compare a
55-year-old couple who has $2 million saved for retire-
ment. Tey had $2.5 million at the beginning of 2008,
but lost $500,000 in the market downturn. Tey’ve been
sitting on the investment sidelines since then because
they’re afraid to get back into the market. Tey sense, as
do many, that our economy is still shaky and that cur-
rent increases in market rates are running ahead of the rest
of the economy and may take another downturn in the
not-so-distant future. As a result of these feelings coupled
with our discussions on the subject, they’ve decided that
they want to keep 70% of their money out of the market
and put 30% back in. However, they even want that 30%
to be invested conservatively. As for the 70% that they
want out of the market, they expect to receive only about
a 3% rate of return on that $1,400,000. As part of our
overall strategy, we will move some of that money, in this
case $500,000, over to a permanent life insurance policy.
Because of the lack of liquidity of the shifted dollars dur-
ing the early years of the policy, we will move that money
slowly over a 15-year period at the rate of about $40,000
per year. Tat premium would produce around $1.25 mil-
lion of permanent life insurance on the husband’s life,
assuming he is relatively healthy. Tis particular illustra-
tion is all base with no paid-up additions rider or other
enhancements. Take a look at this chart, which shows the
cash accumulation of the $500,000 growing at 3% taxable
versus the same money being moved systematically from
the 3% account to whole life at $40,000 per year. [visual]
You’ll notice that, strictly as an asset accumulation device,
it outperforms the 3% account over time. Tat’s partly be-
cause the cash values and dividends on the policy actually
provide a return that is a little better than the 3% account,
and partly because there are tax savings each year as we
move the money from a taxable vehicle to one that ac-
cumulates without tax. You will also notice, however, that
the life insurance is a little bit weaker in the early years
while it suffers from a partial lack of liquidity. Tis, again,
is one of the reasons that we “drip” the money over slowly
rather than all at once. Te other reason is to protect the
tax-favored status of the policy.
So the policy works well as an asset accumulator, but
now let’s see what else it does for us. On this next screen
you’ll see the legacy value of the 3% account compared to
the legacy value of the life insurance policy. [visual] At this
point it may be wise to point out to our clients that they’ll
soon be fortunate not to “need” life insurance anymore.
Teir children are grown, college and weddings are almost
paid for, the mortgage is just about paid off, and they’ll
soon be finished working, so there won’t be any income
to replace. Teir current levels of group and personal term
life insurance should be adequate to take them to the fin-
ish line, and then they won’t really have much need for life
insurance anymore. In fact, unless they have estate issues
to deal with, about the only reason that they would want
to have life insurance in retirement is if the existence of it
could allow them to dramatically increase the net after-tax
income they receive in retirement from all of their other
assets. In other words, it is the existence of the death ben-
efit, once it is no longer needed for traditional protection
purposes, that will allow our clients to take advantage of
all of those other great retirement distribution strategies
we talked about earlier. It is the death benefit of the insur-
ance that unlocks those assets and provides the safety net
needed to do such things as amortization and annuitiza-
tion of their other assets.
336
P R O C E E D I N G S
Why Your Clients Need Value Replacement
Strategies Now
To simplify our discussion, let’s assume that we break
our client’s $2 million into several buckets of money.
While value replacement strategies work with both quali-
fied and nonqualified money, for ease of example we’ll as-
sume that all of their retirement savings is nonqualified.
Te first bucket will hold the $600,000 that the clients
want to keep in the market in a conservative portfolio.
We’ll assume a 6% taxable return on that bucket. Te re-
maining $1.4 million will be broken into three additional
buckets, one with $500,000 which will be “dripped” over
to life insurance, and then two others holding $450,000
each. Te question is: Can the existence of life insurance
cause the remaining three buckets of money to generate a
higher net income in retirement than all four buckets can
with no life insurance?
Looking at $600,000 at 6% taxable and $1.4 million
at 3% taxable, we get a gross income of $78,000 and a net
income of $50,700 per year. If we annuitize the $600,000
bucket and just one of the $450,000 buckets on the hus-
band’s life with no period certain and no survivor benefit,
we get an initial gross income of $80,166 and a net income
of $70,954. Tat’s almost a 40% increase in net after-tax
income, and we haven’t even begun to touch the life insur-
ance cash values or the other $450,000 bucket! Even when
the exclusion ratio drops off and the net income from the
annuity goes down to $52,000, the interest-only income
from the second $450,000 bucket would be more than
$31,000 per year. If the wife dies first, the income contin-
ues uninterrupted because the annuity is on the husband.
At his subsequent death, the life insurance proceeds and
the unused balance of the third bucket would go to the
heirs. If, on the other hand, the husband dies first, the an-
nuity income stops instantly, but the life insurance death
benefit comes in and is always well above the amount the
wife would need to annuitize on her life to replace the lost
income. Te excess not needed for her annuity, along with
any unused funds in the remaining bucket, will provide a
substantial legacy for her heirs.
Results
Tere are many options available to this couple to
distribute their retirement assets more efficiently and at
a substantially greater income level after taxes. Tey have
tremendous flexibility because none of the distribution
decisions need to be made up front. Tey can all be made
at the time of retirement. Even at retirement they don’t
have to decide on their long-term distribution strategy.
Tey will have the opportunity to adjust their income as
time goes on using techniques such as laddering annuiti-
zations to provide an increasing income for inflation and
the other factors that affect cost of living increases. Te
existence of the permanent whole life insurance policy
creates options and opportunities that just aren’t practical
or prudent without it. Often, the additional income that
is created by leveraging the death benefit is so great that
it can completely make up for the money that was lost
in the market. Consider our couple who lost $500,000 in
the market in 2008. At 4% net, after tax, that $500,000
would have thrown off about $20,000 per year in retire-
ment income had they not lost it in the market. Te strat-
egy shown above created an additional $20,000 of net in-
come from their existing assets, completely replacing the
value of the assets lost in the market. Not only does this
strategy replace the lost income, it provides the opportu-
nity for increasing income in retirement, greater legacy to
heirs, better protection from creditors, and all with less
risk, thereby increasing the probability of success.
Value replacement strategies will help your clients lower
the bar of required wealth, live better from the wealth they
have, and gain substantial peace of mind by permitting
them to take the market pressure off the bulk of their as-
sets. We’re simply moving money from one pocket to an-
other to get better returns within that class of investment
while providing more safety, tax advantages, and a death
benefit that can unlock a myriad of additional retirement
distribution options for our clients.