My plan to use policy loans to fund first five years of retirement

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White Coat Investor
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Re: My plan to use policy loans to fund first five years of retirement

Post by White Coat Investor » Fri May 12, 2017 3:53 pm

afan wrote:
White Coat Investor wrote:
My understanding is that you're usually better off taking policy loans last rather than first.
Is that to minimize the risk of the policy lapsing?
That would be my worry with the OP's plan. Take out loans in the 60's and hope that the policy does not lapse over the subsequent decades. This runs the risk of being 95, having spent down a large share of retirement funds and needing to come up with a huge sum to keep the policy going or pay the taxes. By taking loans late, one avoids this risk.

Of course, depending on mortality charges and investment returns, there is a risk that the cash value to support sizable loans might not be there in the later years.
Partially, but mostly just because that money, like all loans, is tax-free but not interest free and sometimes the interest rate isn't very good at all. Whereas a life insurance policy is pretty good for your legacy, so I'd leave it to fund the legacy unless you really need it.

Wade Pfau feels differently though. He thinks borrowing against your house or life insurance throughout retirement can make things "more efficient." I think his main point is that if you're going to spend both the life insurance money and your portfolio, you should withdraw from the portfolio when times are good and the life insurance when the market is down to increase efficiency.
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afan
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Re: My plan to use policy loans to fund first five years of retirement

Post by afan » Fri May 12, 2017 4:26 pm

Interesting idea. I would remain worried about accumulating a large policy loan on the hope that I would die before it lapsed.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

randomguy
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Re: My plan to use policy loans to fund first five years of retirement

Post by randomguy » Fri May 12, 2017 5:13 pm

David Jay wrote:
delrinson wrote:I own the policy...but the feds don't tax it upon my death and as far as I know no state would tax it (but perhaps there are some I'm not aware of). That's certainly worth something....every other asset I know of gets taxed, including retirement accounts.
You paid for your policy with after tax dollars. If you had put those same after tax dollars into a Roth IRA (either directly or indirectly through a "backdoor Roth") then all withdrawals would be tax free (federal). My state does not tax Roth withdrawals.

Admittedly, the Roth IRA did not exist when you took out that policy 26 years ago but the Roth has been around for 20 years.
ROTH are subject to estate taxes if you have a large enough estate. You also run into the problem that you can only put small amounts of money in a ROTH so when you have extra cash you have to put it somewhere.

All that being said, trying to avoid taxes often costs a lot more in taxes. Sure it sounds great avoiding paying 400k in taxes. But if you end up with 1 million dollars instead of 2 million, you didn't really win by minimizing your taxes.

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Re: My plan to use policy loans to fund first five years of retirement

Post by djscal » Fri May 12, 2017 6:47 pm

What is not being said about these permanent life insurance policies is the typically very high expenses that one pays for these policies. So high in fact that there is only 1 winner in these policies and it's not the policy holder.

Between the M&E fees (which are very high even early on when one is young because it's a permanent policy), the policy administration fees, early cancellation fees, the investments fees (the mutual fund choices typically have very high costs AND often transaction fees to buy / sell). The insurance company paper cuts you to death in fees.

Now OP wants to borrow from his policy at 5% and pay the insurance company EVEN more in fees. Yikes.

These high fees are against everything that we stand for at Bogleheads.

I analyzed a NorthWest Mutual universal life policy that my wife purchased when she was single and I nearly puked when reading the policy documents and seeing how the investment actually turned out.

She was in the policy for about 10 years and the fees eroded the majority of her gains.

She ended up making $2500 in profit after "investing" for 10 years after a total contribution investment of about $35k. The IRR that the insurance company projected when she purchased the policy was 8% - laughable.

There were some cancellation fees (a few hundred dollars because she cancelled before having the policy for 15 years - but I could not bear to continue to pay into that horrible monstrosity any longer).

OP maintains that this policy is a good investment - death benefit aside because he could have a term policy - I'd challenge him to compare what that same investment would have produced by investing in low cost funds at Vanguard (and adding the cost of a term policy).

It's extremely unlikely that his universal policy wins.

slowbutsteady
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Re: My plan to use policy loans to fund first five years of retirement

Post by slowbutsteady » Fri May 12, 2017 9:34 pm

delrinson wrote:Currently in our mid 50's, we tentatively plan on retiring at 65. We do not plan on taking Social Security until 70 nor touching retirement accounts until 70-1/2 when RMDs begin.

Our current plan, from age 65-70, is to fund about half of our retirement income with loans from our life insurance policies. We have had our carrier run illustrations for us...it looks like we could do this for five or six years, not take out any more loans nor repay existing loans, and the policies would still have some cash value when we turn 100. The reason I like this approach is that it would enable us not to sell any assets until we turn 70....we could live off of income from loans and dividends from our taxable account. And of course, if we wanted to, we could sell some equities and borrow a bit less from insurance.

Any thoughts on this general approach? Any downsides I may be missing?

Thanks.
I have a whole life policy as well but with the primary intent of keeping it permanently. Not planning to take loans out, but as one never knows, thus my curiosity about your question.

If I were in your shoes, I would delay as long as possible (or consider only during down markets in retirement as a few other have pointed out). From where I stand today, my priority during the bridge years is to transfer as efficiently as possible from 401k/IRA to Roth.

On the broader note of WL's dislike on this board, it's understandable and I take no offence. Not suitable for most and one needs to be careful when discussing WL so that others reading the site do not assume it's fine for them as well just because some of us on the board own one.

But critics should also recognize that personal finance/ investmemt is more than simply maths of returns. There are several personal circumstances, experiences, and behavioural nuances beneath investment preferences and decisions...a.k.a YMMV
Last edited by slowbutsteady on Fri May 12, 2017 9:57 pm, edited 1 time in total.
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Dottie57
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Re: My plan to use policy loans to fund first five years of retirement

Post by Dottie57 » Fri May 12, 2017 9:50 pm

I think the dislike of whole life on this board is when it is purchased as an investment. When purchased as permanent insurance and with eyes wide open, it can work.

For me - I like investing with simplicity.

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Re: My plan to use policy loans to fund first five years of retirement

Post by MossySF » Sat May 13, 2017 12:02 am

Talk about past expenses paid are under-the-bridge.

Not sure if taking loans out is the best plan to be honest. If your goal is to leave money for heirs and your policy is death benefit + cash value, I'd draw down on other retirement assets first. My opinion here is primarily driven by the loan interest rate of 5% -- that seems pretty high for using your own money -- and I'd be worried that the interest would snowball and cause a future policy collapse. (As a point of comparison, I have a permanent life policy with a loan rate of 2%.)

afan
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Re: My plan to use policy loans to fund first five years of retirement

Post by afan » Sat May 13, 2017 6:04 am

delrinson wrote: I own the policy...but the feds don't tax it upon my death and as far as I know no state would tax it (but perhaps there are some I'm not aware of). That's certainly worth something....every other asset I know of gets taxed, including retirement accounts.
If you own the policy it is part of your estate and would be taxable at your death.

Right now that figure is well below the federal estate tax minimum. Adding your death benefit to the rest of your assets yields the taxable amount. Some states have estate or inheritance taxes that kick in at much lower numbers. So even without a change in federal estate taxes your death benefit could be subject to death taxes at the state level. If you are not a resident of such a state when you die and the federal estate tax minimum does not decline you would not owe estate taxes, but the money would be part of your estate.
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Re: My plan to use policy loans to fund first five years of retirement

Post by kmurp » Sat May 13, 2017 8:05 am

delrinson wrote:Just to give you all an idea of the hard numbers. One policy I've had for 26 years. If I die today, the amount of the death benefit would represent a 9% annualized increase, all tax free. Actually more than that if you subtract the term premiums that would have been in place in the absence of the permanent policy. Hence my view that it's a good investment....provided that the investment horizon extends to the day of my death.
That is really good if your numbers are correct. My policy of a similar age has increased the death benefit (using reinvested dividends) but slightly less than the rate of inflation if I ran the numbers right. And I didn't try to include any portion of premiums paid as additions in my calculation.

afan
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Re: My plan to use policy loans to fund first five years of retirement

Post by afan » Sat May 13, 2017 10:42 am

You always get a better return at death the sooner you die. Term will beat cash.value.

The relevant question here is the rate of return on your cash value.

What return will you get and how will your plan work using guaranteed, not projected, returns?

If you still have it, compare the projected ta le from when you bought the policy to what you actually got.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

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Re: My plan to use policy loans to fund first five years of retirement

Post by delrinson » Mon May 15, 2017 7:55 am

So I guess it WOULD be subject to estate tax...unless I arranged a change of ownership. Not a huge deal, given the federal threshold.

Carrier is Northwestern, which certainly has a long and solid track record of paying dividends. Running the numbers from the NML illustration:

Die today, 8.9% annualized return.

Die at 65, 6.3%.

Die at 75, 4.9%

Die at 85, 4.2%.

Die at 95, 3.7%

And these numbers would be a bit higher were it not for the fact that I had the dividend go toward reducing premium for a number of years.

I'm fine with those returns given it's part of the fixed income portion of my portfolio and given the flexibility that the policy affords.

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Re: My plan to use policy loans to fund first five years of retirement

Post by David Jay » Mon May 15, 2017 9:27 am

delrinson wrote:So I guess it WOULD be subject to estate tax...unless I arranged a change of ownership. Not a huge deal, given the federal threshold.

Carrier is Northwestern, which certainly has a long and solid track record of paying dividends. Running the numbers from the NML illustration:

Die today, 8.9% annualized return.

Die at 65, 6.3%.

Die at 75, 4.9%

Die at 85, 4.2%.

Die at 95, 3.7%

And these numbers would be a bit higher were it not for the fact that I had the dividend go toward reducing premium for a number of years.

I'm fine with those returns given it's part of the fixed income portion of my portfolio and given the flexibility that the policy affords.
The problem with all life insurance illustrations is that they are in nominal dollars. Try this:

1. 2% inflation
2. Die @ 85
3. 5% loan interest for 20 years (65-85)

I really don't like that outcome...
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