Buy life insurance on your parents to guarantee a retirement nest eggArticle added by Roccy DeFrancesco on July 13, 2010
Roccy Defrancesco

Roccy DeFrancesco

MI

Joined: May 24, 2006

Today there are millions of younger Americans (those under 50) who live in fear when it comes to the idea of growing wealth for retirement. Most don't think Social Security benefits will be sufficient. Most saw their stock portfolios tank 59 percent or more during the last stock market crash. The reality is that there are millions of people who have no idea how they are going to amass enough money to retire on when they turn 65 to 70 years old.

Sure, they could use Retirement Life(TM) (RL) to grow money in a tax-free manner with low risk and good upside growth. But as much as I like using RL to grow wealth, there is no guarantee.

Creating a "guaranteed" retirement nest egg

How would you like to introduce your younger clients to a way that they generate a "guaranteed" retirement nest egg? Would your clients be happy with a guaranteed benefit of between 10 percent and 16 percent (gross) throughout a 20- to 25-year period? I think we all know the answer to this question.

Buying life insurance on your parents

I sometimes get in the habit of talking about using cash value life insurance (CVL) on 25-55 year olds as one of the best tax-free/wealth-building tools. What I forget is that life insurance can be one of the best guaranteed wealth-building tools for children who have living parents.

Instead of pontificating about why a son or daughter should consider buying life insurance on a parent to guarantee a tax-free pool of money that can be used in retirement, let me just go through a few pretty common examples.

Example 1

Assumptions: The son is 40, while mom and dad are both age 65 and in good health. The son has $15,000 a year to buy a second-to-die life policy on both parents until they both die.

How much guaranteed death benefit can the son buy on the parents with a $15,000 a year annual premium? $1,311,595.

What's the comparison? What would the son have normally done with $15,000 of investible money each year? Let's assume he would have invested it with a money manager, who put the money in mutual funds. I will assume a 20 percent blended capital gains/dividend tax on the growth and a combined 1.5 percent annual expense that includes both mutual fund expenses and a money management fee for the broker. This is a conservative example from an expense standpoint.

The question: What rate of return did the mutual fund account need to return in order to accumulate $1,311,595 by various ages? See the following charts. The first chart assumes that both parents are preferred for underwriting. Notice that the gross rate of return if both parents live until age 90 is 11.98 percent (meaning that the $15,000 that was invested in mutual funds every year had to return a gross rate of return of 11.98 percent every year for 25 years to match the after-tax benefit from the life policy).

Age of ChildAge of ParentNet Rate of ReturnGross Rate of Return
608511.66 percent16.45 percent
65908.08 percent11.98 percent
70955.86 percent9.20 percent
751004.37 percent7.34 percent


The following numbers are if both parents are "standard" for underwriting. Because of the standard rating, the guaranteed death benefit would be $1,117,063.

Age of ChildAge of ParentNet Rate of ReturnGross Rate of Return
608510.43 percent14.91 percent
65907.08 percent10.73 percent
70955.01 percent8.14 percent
751003.63 percent6.41 percent


Example 2

Because not everyone has two parents, let's look at an example where the life insurance policy purchased is on the client's mom, who in the first chart I'll assume is preferred for underwriting. The guaranteed death benefit is $925,258.

Age of ChildAge of ParentNet Rate of ReturnGross Rate of Return
60858.98 percent13.10 percent
65905.90 percent9.25 percent
70954.00 percent6.88 percent
751002.74 percent5.30 percent


The following numbers are if the mom is "standard" for underwriting. Because of the standard rating, the guaranteed death benefit is $732,993.

Age of ChildAge of ParentNet Rate of ReturnGross Rate of Return
60857.14 percent10.80 percent
65904.39 percent7.36 percent
70952.70 percent5.25 percent
751001.59 percent3.86 percent


Pros and cons of buying LI on parents

The numbers above are very, very powerful. Consider that according to a recent DALBAR study, the average mutual fund investor from 1998-2008 returned 1.87 percent. Compare this to the idea of investing in a life policy where the rate of return should, at the very least, equate to a 5.25 percent gross rate of return using the non-standard single female parent numbers. Or, on the high end, to 16.45 percent for a second-to-die policy on two parents who both die at age 85.

Pros:
  • Guaranteed returns that are likely to outperform or significantly outperform returns in the stock market

  • No stock market risk (this is a non-stock market correlated asset)
Cons:
  • You don't know when the parent(s) is going to die, so it's tough to budget for retirement at a specific time. Having said that, if the life settlement market is still around when a client is in retirement, he/she can sell the policy at anytime the parent(s) are over the age of 70.

  • The parents have to be relatively healthy for this to make sense mathematically; the policy design has very little, if any, liquidity.
Summary

Buying life insurance on a parent is not a silver bullet that will cure every client's need to create a tax-free retirement nest egg. However, for clients who want a properly balanced portfolio, buying LI on one or both parents is nearly a no brainer from a mathematical point of view if the parents are standard underwriting or better.

I wouldn't take this concept to your lower or even lower middle class clients; however, if you have clients who are in the middle class or higher, having them allocate as little as $5,000 a year and as much as $50,000+ a year toward buying a life policy on one or more parents can be a terrific way to diversify a portfolio.

Finally, insurable interest is not an issue.

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