Retirement Income Strategies

Permanent Life Insurance – the Utility Player of Holistic Financial Wellness

It was 1979. I had just graduated college and was working as an actuarial student at Connecticut General Life Insurance (“CG”) when I met my first Life Insurance salesman. John Greer was not a colleague or a workshop leader assigned to teach me the actuarial intricacies of any particular CG product. Rather he was a Northwestern Mutual Life sales agent barely out of college himself attempting to sell me (a single 23 year old guy) permanent life insurance! How he came up with the idea to infiltrate another insurance company (CG had its own line of policies) in order to sell insurance to actuarial students, I will never know, but clearly John (http://www.johngreer-nm.com/) was, and still is an “out of the box” thinker who is well worth knowing.

The fact is that John closed that sale and I went on, over the next 20 years, to buy 4 more policies from him, all of which I still own today. This may say something about John and his ability to sell, but I think, even more importantly, it says something about the power and versatility of what is perhaps one of the actuarial profession’s greatest inventions and an important contribution to Society. I’m talking about the humble Life Insurance Policy. The concept of life insurance goes back to Roman times, but the life insurance policy as we know it today was created by UK actuaries at the Equitable Life Assurance Society in 1762, (a company that flourished for over 200 years until it was undone in the early 2000’s by straying into the dangerous waters of guaranteeing the seemingly safe interest rate of 7% on almost $10 billion of annuity liability).

Despite being owned by vast numbers of individuals and organizations, Life Insurance is almost certainly the least understood  of the “standard” financial instruments that individuals and organizations (private, public and not-for-profit) use in the financial management of their enterprises. More importantly, it can also be a critical component of any individual’s plan to achieve holistic financial wellness. The reason for this is simple. Over time a life insurance policy can perform many different interrelated functions that will help ensure your financial wellness. These include capital accumulation, tax minimization, family protection, estate planning and even cash flow management. It may not be the best at any particular function, but like a great utility player on a baseball team, life insurance can be used for different roles at different times in your life and is always a good resource to have on your bench when a particular need arises. In short, Life Insurance is like Ken Zobrist of the Chicago Cubs; maybe not a candidate for MVP, but a valuable player nonetheless who richly deserves a spot on your roster.

The history of life insurance and the twists and turns of how its various uses evolved is in and of itself a fascinating story but well beyond the scope of this piece. Today, there are many different types of life insurance, with three of the most important being Guaranteed Renewable Term (“GRT”), Variable Universal Life (“VUL”), and Whole Life. In future posts I will talk about GRT and VUL, both of which can be used by organizations as well as individuals for financial management, but today I want to talk about Whole Life as, in my view, it has been subject to a great deal of unfair criticism and yet is one of the most important tools available to ensure your holistic financial wellness.

Whole Life is what I bought from John as a 23 year old, and for a young person just starting out in the world it can be one of the smartest purchases you will ever make. For almost 40 years, I paid a small premium every month into a vehicle that provided me with both insurance protection and a tax sheltered investment. Some of my premium went to paying for a death benefit (the “cost of insurance”), but the vast majority went to the “Cash Value” which was an investment account that received guaranteed interest and accumulated tax free. Initially the death benefit was very modest ($20,000 if I remember right) but with the additional policies I purchased in the ensuing years, the death benefit ultimately grew to almost $1million. Thankfully it never got paid. Even though I survived, and in some sense a portion of my premiums were “wasted”, the presence of that protection gave my wife and son the significant comfort of knowing that in the event of my untimely demise they would be taken care of. That comfort (and the steps that my wife did not have to take as a result) contributed to our family’s financial wellness and should not be underestimated. Furthermore, because I was so young when I bought the policy, the cost of insurance was very modest and continued that way for the life of the policy. In fact, even after considering that cost of insurance, the Cash Value accumulated at a compound tax free annual rate of almost 6% and as of last year that “forced savings account” was worth more than $400,000.

But my policies were even more valuable than that. As my financial life got more complicated and I moved from city to city, bought and sold houses, got married, divorced and married again, there were times when I needed cash, sometimes a lot more cash than I had readily available. And so several times I was able to borrow (essentially from myself) amounts I needed from the policy and pay myself back over a period of time and at a rate that was completely within my control. In short, the Cash Value provided a “buffer” that allowed me to get over the “liquidity bumps” that we all face as we make our way through life.

Recently, because I am about to retire, I converted my policies into “reduced paid up status”. As a result, two more extraordinary features of my policies have come into focus each of which will be extremely valuable to me in the years ahead. First, about one half of my $400,000 cash value is considered “cost basis” that I can withdraw and spend any time I want and never pay tax on it. It is a powerful source of emergency savings that I can tap into should an unforeseen contingency arise. Second, and even more importantly, I now have a guaranteed death benefit of $800,000 that will go to my wife (or other beneficiary if she dies first) tax free.  If I were to try and buy such a benefit today it would be extremely expensive and maybe not even available without undergoing a full medical exam. This is not only valuable in and of itself, but that $800,000 death benefit will allow us to withdraw more from our 401(k) savings than otherwise, because we know that we only have to use that money while I am alive and that after I am gone the life insurance will take care of the rest. That is what holistic financial wellness is all about.

Holistic Financial Health (cont.) – More on Reverse Mortgages

The first time I met Barry Sacks was almost 20 years ago when he was brought in to help one of my clients solve a fiendishly complex tax/legal problem that had arisen in the bargaining between my client and its major Union. Arriving a few minutes late, he was clearly excited, but not about the tax issue. After some brief hello’s he told us about the brilliant idea he had for a new invention that occurred to him on the way over to the meeting. Pulling a single credit card from his overstuffed wallet, he asked us to consider all the wasted space (“real estate” as he put it) on the card that currently was taken up by a Bank logo and a background picture. Specifically, he asked, why couldn’t all that space be used to incorporate the information that all of the other cards in his wallet contained? Just like the “universal remotes” that were then all the rage in the electronics industry, he suggested that with his innovation, we all could have a “Unicard” that could be used for all the electronic transactions that we currently conduct, from department store purchases to borrowing books from the local library. As Barry waxed eloquent about all the convenience and financial efficiencies of such an invention as well as the easily surmountable technical challenges associated with its introduction, the client and I sat there both enthralled and a little taken aback at the unexpected turn the meeting had taken.

As I got to know Barry better I found that this incident was by no means an unusual occurrence with this curious and creative polymath. With a Ph.D. in physics from MIT, Barry had started his career in academia and was well on his way to becoming a tenured professor, when he suddenly decided that tax law would be much more interesting than electromagnetism and lecturing undergraduate students. He went back to law school and very quickly became one of the leading ERISA attorneys in the Bay area. By the time we met, he was a partner at one of  San Francisco’s boutique law firms and a specialist in the complex and unusual legal issues that often arise in the pension world. Many of these problems had actuarial aspects and, as a result, over the years Barry and I got to collaborate on a number of fascinating client projects.

Despite his demanding “day job”, Barry is an unapologetic “out-of-the-box” thinker who is constantly coming up with new ideas and new approaches to old problems. He currently holds several patents (not including his idea for the “Unicard,” which in some ways has been incorporated into smartphone technology) in fields ranging from physics to financial engineering, but his current passion is Reverse Mortgages and how this obscure, much maligned and poorly understood financial vehicle can be used in creative ways to not only augment one’s retirement income, but to become an integral part of a “decumulation” strategy after retirement.

In a previous post I mentioned how considering the value of your house (and any mortgage debt) as an integral part of your personal balance sheet is a key component of a holistic approach to financial health. Digging a little deeper, let’s now look at why and how a Reverse Mortgage Credit Line can be a powerful tool to unlock and utilize that value to ensure a financially healthy retirement.

A Reverse Mortgage Credit Line is actually nothing more than a loan against the value of your home. It operates just like a traditional home equity line of credit (HELOC) with two critical distinctions. First, unlike a HELOC, when you set up a Reverse Mortgage Credit Line, the amount you can draw down is not fixed, rather it grows every year, and not just with the increase in the value of your house, but at a stated annual rate. So, for example,  if you set up a Reverse Mortgage Credit Line for $200,000 at age 65 and don’t use it until age 75, by the time you start taking cash, the amount available might be $300,000 or even more. This in itself is a valuable way to assure yourself that you will have access to funds later in your retirement should you find your other sources of retirement income drying up, but the second difference between a HELOC and a Reverse Mortgage Credit Line is even more important; that is you don’t have to pay back the Reverse Mortgage until you sell or move out of your house, and you will never have to pay back more than the residual value of your house REGARDLESS of what the real estate market does

This second difference is what turns a Reverse Mortgage Credit Line from a source of “emergency funds” into a powerful retirement income generation tool that, when part of a sophisticated and highly effective decumulation strategy, can take you from a situation of having to worry about outliving your assets to a situation where you can comfortably draw down 6%, 7% or even 8% of your savings every year and still be confident that you have very little chance of running out of money before you die.

What is the magic? This is where Barry’s work comes into play. The technical details can be found at

https://www.onefpa.org/journal/Pages/Reversing%20the%20Conventional%20Wisdom%20Using%20Home%20Equity%20to%20Supplement%20Retirement%20Income.aspx .

In essence, what Barry discovered was that setting up a Reverse Mortgage Credit Line enables you to draw money from two sources, which can be coordinated.  That is, instead of drawing money every year from your 401(k), IRA or other retirement savings account, you draw from your retirement savings account only if the investment returns (in the prior year) on that account were positive, and draw from the Reverse Mortgage Credit Line if the account’s investment returns (in the prior year) on were negative.  This strategy allows the invested securities in the retirement savings account to better recover their values in the years following the years of negative returns than if they had been drawn on immediately following the negative returns.  It has been clearly demonstrated that if the negative investment returns occur in the early years of retirement, and the account is drawn on in the years following the years of negative returns, the likelihood of the account becoming exhausted in the later years of retirement is much greater than if the account is not drawn on immediately following the negative returns.  This coordinated strategy minimizes what is called the “sequence of returns” risk, associated with market volatility. In short, using this strategy allows you to draw on the account at a higher rate, for a longer time, than you otherwise might.

Some decisions don’t require the 5-step Present Value process and I believe that taking out a Reverse Mortgage is one of them. At first glance, the strategy above might seem like “smoke and mirrors” and that there might be hidden risks associated with the strategy (e.g. losing your house). However, as you will see in Barry’s paper, none of these potential risks are material. Try as I might, I can find no flaw or material risk in the strategy. In fact as far as I can see, unless the rules around Reverse Mortgages change in a pretty dramatic way, this is a winning strategy for holistic financial health that everyone who has a house and a 401(k) should seriously consider no matter what their personal rate of discount is.

Holistic Financial Health (cont.) – Present Value and Leaving a Legacy

I ended my last post noting that when we consider the future and determine our personal rate of discount we should not limit ourselves to the “rest of our life”. In fact, if you are like most people you care a lot (though maybe not quite as much) about what happens after you leave this world. Except for the very wealthy, very few of us (and even fewer financial planners) really take a hard look at what this implies for how we should manage our financial life both before and after we retire.

As a practical matter, when it comes to financial decisions, what this means is that  not only should you consider those scenarios where you don’t exhaust all your assets, but you should also think about other financial steps that you can take to leave something behind. In addition to your house there are two other mechanisms for leaving a legacy that are worth mentioning now and will be explored more deeply in future posts. The first is Life Insurance which many financial planners will likely suggest should be part of your financial strategy. As powerful and effective as it can be (for protecting your family while working, for generating retirement income, and for leaving a legacy) Life Insurance products are very complex, and purchasing policies as well as managing them well can be a daunting task.

The second and less well known vehicle that can be used to both generate retirement income and leave a legacy is a Charitable Gift Annuity (“CGA”), which even though considered a “Planed Gift” by the philanthropic community, can also be considered as a (not so traditional) retirement planning tool. Steve Vernon as well as many others have explained how effective annuities in general can be in ensuring your financial health. See for example Steve’s post at http://www.cbsnews.com/news/understanding-how-you-can-use-immediate-annuities-to-fund-your-retirement/  .

With respect to Charitable Gift Annuities, this link,  http://www.nolo.com/legal-encyclopedia/charitable-gift-annuities.html   can give you some basic information on how CGA’s actually work, but for now just know that CGA’s operate like any other annuity that you might buy from an insurance company except that instead of allowing a big corporation to make money on your purchase, the “profits” on a CGA go to the Charity that you got it from. You can obtain a CGA from almost any large not-for-profit organization, University or Charity. I purchased one from my old school, but many people get them from large Charities whose mission they believe in.

In order to get a CGA you must first make sure the Charity of your choice has a CGA program. To find out, just call them up and ask for their “Planned Giving “ department. After you transfer funds to the organization you have chosen, they will provide you (based on a legally binding contract) a guaranteed stream of payments starting either now or at some specified date in the future and those payments will continue for the rest of your life. The only difference between this and an annuity purchased from an insurance company is that in addition to the guaranteed lifetime income you get, you also receive an immediate tax deduction for the Present Value of what the Charity expects to recover from the transfer after you die and all of the annuity payments had been made.

In essence, obtaining a CGA allows you to provide yourself guaranteed retirement income, leave a legacy and get an immediate tax deduction for the profits that otherwise would have gone to an insurance company had you bought a more “traditional” annuity. To my mind a CGA is a great way to invest your retirement savings in a vehicle that can play an integral role in your decumulation strategy while at the same time benefiting a cause you believe in.

Of course it is not quite that simple (e.g. CGA’s can be expensive and tricky to obtain), and we will delve into more of the details in a future post. If you can’t wait, you can always read Chapter 12 of “What’s Your Future Worth?” and get the full story of my CGA purchase and take on the world of Planned Giving. In that chapter, as well as throughout the book, the message is the same – ask the experts for help in imagining the future and evaluating what might occur (steps 2 and 3 of the Present Value process), but don’t ever let others set your personal rate of discount (step 4)  by telling you how much (or little) value to place on what you get/give today vs what comes your way tomorrow or even in the distant future when you are gone but the world is still spinning and those you care about are still  around.

That is what holistic financial health is all about.

More on Holistic Financial Health – Present Value and the Rest of Your Life

In my last  post I talked about how important it is to use  your personal rate of discount and to think “holistically” about your financial life. In particular, I spoke about how critical this is during your working years when you are accumulating assets of all kinds and incurring both near term and long term liabilities. That need to consider your whole balance sheet does not end when you stop working and consider the rest of your life, and in this post we will talk about that (looming and long) period of your life

While what I said in the last post about holistic financial health might be considered idiosyncratic and contrary to mainstream financial planning, there is one financial expert who, when it comes to the “decumulation” phase of life, has been advocating the holistic approach for nearly a decade. His name is Steve Vernon, and those who read “What’s Your Future Worth?” may remember him as the actuary who wrote 5 excellent books on planning for retirement and started a consulting firm called, appropriately enough, “Rest of Life Communications” ( http://www.restoflife.com/ ). To my mind there is no one better than Steve in helping you think through the challenge of converting all that you have accumulated into income that you can live on.

I had dinner with Steve last week, and I got the opportunity to hear about the fascinating current research projects he is involved in, but mostly our conversation focused on the more general problem of how to help people manage their financial world, both during their working years when income (generally) exceeds outgo as well as afterward when the reverse is true. Steve and I are very much on the same page when it comes to taking a holistic approach to financial decision making and if you want to get his take on the big picture of how to approach the problem, you should check out this article http://www.forbes.com/sites/nextavenue/2014/11/12/how-to-generate-retirement-income-from-savings ) as well as this post http://www.cbsnews.com/news/3-ways-to-turn-your-ira-and-401k-into-a-lifetime-retirement-paycheck/  where he lays out most of the possible ways to generate retirement income and this example where Steve explains one of his “retirement income generating strategies” http://www.cbsnews.com/news/understanding-how-systematic-withdrawals-affect-retirement/ .

As extraordinary and on target as Steve is, there are a couple of areas/techniques that Steve generally passes over but I believe should also be considered when you think about your entire financial life and your objectives. It is those areas I would like to briefly describe now, and in future posts I will expand a bit and provide a more complete explanation of why I think they are so important.

Perhaps the most important area that I think needs to be integrated more tightly into a holistic view of financial health is the real estate most of us own. I spoke last time about considering both the value of your house and the mortgage you pay as a key part of your personal balance sheet, but the value of your house goes well beyond being just a (usually) good financial investment and a place to live. Your house can also be used, to use Steve’s term, as another “retirement income generator”. I alluded to this point last time when I introduced the concept of a “reverse mortgage” which is essentially a home equity loan with no need for repayment until you sell or move out of your house. The availability and the effectiveness of this income generator is growing and becoming better known, and in the coming weeks I will devote an entire post to reverse mortgages and the role that they can play in your decumulation strategy, but for now I would just direct you to two links that can provide you with some basic knowledge on the subject. The first is http://crr.bc.edu/wp-content/uploads/2014/09/c1_your-house_final_med-res.pdf which is an excellent discussion of reverse mortgages and the use of home equity in general put out by a group with no financial interest in having you buy anything. The second is  https://www.onefpa.org/journal/Pages/Reversing%20the%20Conventional%20Wisdom%20Using%20Home%20Equity%20to%20Supplement%20Retirement%20Income.aspx  which is a paper published by Barry Sacks (an expert in the field) that pretty clearly demonstrates the benefits of incorporating a reverse mortgage into your decumulation strategy. In the future we will discuss both of these pieces in greater detail.

As described in the links, contrary to popular myth, taking out a reverse mortgage does not mean that your children will be deprived of their legacy. Beyond that, and implied in much of what passes for financial planning these days, is the notion that the ideal “decumulation” strategy will result in an exact match of your income and your life expectancy, i.e. that if you die without having spent all your assets (except for the house) you will not have gotten the “most” out of your retirement. I disagree, and think that for most of us, our planning horizon does extend beyond our lifetime and includes a concern for both the loved ones we leave behind and the world that they will live in. In fact, to truly take a present value approach to managing your financial life you need to imagine that part of the future (when you are gone but others that you care about are still around) and consider how much value you place on it vs the current time frame and the mid-term future that comprises your retirement years. In terms of the ideas in “What’s Your Future Worth?” this means that when considering your decumulation strategy, you need to make sure you don’t skip step 2 (imagining the future) and step 4 (developing your personal rate of discount) all the while considering a time horizon that extends beyond your death.

Next time we will delve more deeply into this notion and talk about 2 or 3 other financial products that you should consider as well as part of your holistic approach to ensuring your financial health for the rest of your life and beyond.