Retirement planning for many children has become tough since the economy has become so unstable. Most people never considered purchasing life insurance on their parents. However, while unconventional, this can be a great way to generate guaranteed tax free income for retirement. The following article discusses the benefits of buying life insurance on parents and compares some numbers to highlight why this could be a wise choice.
Tax Free Retirement Planning: Life Insurance on Your Parents will Guarantee a Retirement Nest Egg!
Millions of people who are currently under the age of 50 who have few things they approach with trepidation as when they sit down to consider planning for retirement. It is unlikely that Social Security benefits as we know them will even be around when they retire. A lot of people who have to begin thinking about retirement planning have suffered some substantial losses in their stocks due to recent crashes in the market. These factors have made it very difficult for younger people to see any options when planning for retirement. Most are wondering how they will ever be able to save enough money to survive when they retire.
Life Insurance of Parents for Children’s Retirement
If having a guaranteed benefit that would range between 10-16% gross sounds attractive, an option to achieve this goal over a period of 20 or so years would be to purchase a life insurance policy on your parents. The majority of people believe life insurance is for younger people. Advisors will suggest anyone between the ages of 25 and 55 to buy a policy. While this will offer protection and some income for heirs, how can someone use a life insurance policy for their own benefit? The answer is to buy a life insurance policy on your parents.
This may sound unconventional, but the option has many benefits. We will use some examples to display how insurance on your parents can be a great way to generate money for retirement.
Example #1 of Child Buying Life Insurance on Parents (Mother AND Father)
We will assume that a child (son or daughter) is 45 years of age and has healthy parents who are in their 60s. The child has funds available that will allow for the purchase of a second-to-die policy on both of the healthy parents. The amount being spent would be $17,000 per annum. If the premium each year is $17,000, what would the guaranteed death benefit be on such a policy? The benefit would be worth $1.5M!
What if the life insurance policy was not purchased?
If the child decided to spend the $17,000 in other ways and not buy the life insurance policy, we will make the assumption that an investment in mutual funds has been made with the money. Using a conservative example, we will say there is a 20% capital gains tax on any growth as well as 1.5% for annual expenses.
Life Insurance vs. Mutual Fund Returns
In order for the mutual fund to accumulate the amount that would have been received from the life insurance, being $1.5M, what would the rate of return have to be? This is addressed in the charts that follow. These charts assume that each of the parents is preferred for underwriting. The end result is that the mutual fund would have to return more than 12% every year for 24 years in order to generate the same amount of money as the insurance. When was the last time that happened more than 3 years in a row?
Mother AND Father are Underwritten “Preferred”
| Age of Child | Age of Parent | Rate of Return After Tax | Rate of Return Before Tax |
|---|---|---|---|
| 55 | 80 | 14.9% | 20.3% |
| 60 | 85 | 11.7% | 16.5% |
| 65 | 90 | 8.1% | 12% |
| 70 | 95 | 5.9% | 9.2% |
Mother AND Father are Underwritten “Standard”
The chart below is based on the fact that the parents are “standard” for underwriting and not preferred. This would cause the death benefit to decrease to about $1.2M.
| Age of Child | Age of Parent | Rate of Return After Tax | Rate of Return Before Tax |
|---|---|---|---|
| 55 | 80 | 14.1% | 20.1% |
| 60 | 85 | 10.4% | 14.9% |
| 65 | 90 | 7.1% | 10.7% |
| 70 | 95 | 5.0% | 8.14% |
Example #2 of Child Buying Life Insurance on Single Parent (Mother OR Father)
Another example � We all know that having two healthy parents is not the norm. If the life insurance policy is only purchased on one parent with preferred underwriting status, the death benefit would then amount to $925K.
Mother OR Father is Underwritten “Preferred”
| Age of Child | Age of Parent | Rate of Return After Tax | Rate of Return Before Tax |
|---|---|---|---|
| 55 | 80 | 12.4% | 17.3% |
| 60 | 85 | 9.0% | 13.1% |
| 65 | 90 | 5.9% | 9.3% |
| 70 | 95 | 4.0% | 6.9% |
Mother OR Father is Underwritten “Standard”
The chart beneath displays the numbers for a standard underwriting of one parent with a death benefit of $733K.
| Age of Child | Age of Parent | Rate of Return After Tax | Rate of Return Before Tax |
|---|---|---|---|
| 55 | 80 | 11.1% | 14.9% |
| 60 | 85 | 7.14% | 10.80% |
| 65 | 90 | 4.4% | 7.4% |
| 70 | 95 | 2.7% | 5.3% |
Buying Life Insurance on Parents: Disadvantages & Advantages
The numbers in the charts above can help clients understand how buying life insurance on their parents will provide more money. It would be necessary for mutual funds to have a huge rate of return for many years in order to generate the same amount of money as the death benefit from a policy.
There are some advantages of purchasing the life insurance instead of investing in mutual funds. The returns of a life insurance on parent(s) will be guaranteed and will most often surpass the returns that are generated in the stock market. The risks are also much lower than gambling in the market.
However, there are some disadvantages to this life insurance option as well. It is impossible to know when a parent will pass on. This can create challenges when trying to plan for retirement. The individual does have the option to sell the life insurance policy if the parents are over the age of 70, but both parents will have to be in poor health and the policy will likely have very little liquidity depending on the life settlements market at that time.
Purchasing a life insurance policy on healthy parents is one way to plan for retirement and guarantee an income. It is important for the parents to be in good health. This option would not be beneficial for individuals who have failing health. In addition, the life insurance policy is a way for the client to diversify their portfolio. The life policy is also not for children who are in the lower than middle class income range. Paying premiums of $5,000 to $50,000 on your mom, dad or both creates the best benefits of your retirement planning based on the empirical data.
Contact Estate Street Partners to discuss how we can help you plan for retirement when purchasing life insurance for your parents or if we can assist with any other retirement strategy.