Income is cash you can spend. You need income once you retire. Think about someone with a Defined Benefit Pension Plan from their employer. This person doesn’t have to save a dime toward retirement because their employer’s pension will continue to provide an income when they retire. Income is what matters.

Permanent Life Insurance should make up the foundation of your retirement savings. You need a firm foundation before you can build upon it. This is the first money in that will provide for your family if you die young. This is also the safe money that will earn attractive yields with principal protection. This money will provide for your family whether you die early or live a long healthy life. Once you have a solid foundation, THEN you can allocate savings to higher risk/higher return assets.The balance of your portfolio –during your saving years–should be in safe financial alternatives that will provide superior returns with much less risk than traditional Wall Street investments. Once you retire, some of your assets can be shifted into liquid assets that can be sold to generate income.

As you begin to understand that you get income from your life insurance policy by borrowing against the cash value, you will understand that because the cash value never leaves the policy, it continues to grow despite the loans. This is what allows the cash value of a life insurance policy to generate two to three times the income from the same amount of savings.

Recognize that you don’t take distributions from a Life Insurance policy like you do with a 401(k). You get loans from the insurance company that are secured by the cash value of the policy. This is why the income is tax free: it is a loan.

What follows is an important aspect of retirement planning using life insurance that may not be totally obvious to you: when you use a Life Insurance Retirement Plan (LIRP), the “bucket” of funds that you have saved all your life continues to grow even after you start taking  tax-free income! Again, as long as the rate of return on the equity in your policy exceeds the borrowing rate on your loans, your entire bucket will continue to grow even after you start taking income.

Just how much can a retiree take out of their savings every year for the rest of his life? Financial Advisors use the 4%-Rule to determine the safe withdrawal rate so that savings aren’t depleted. Don’t take my word for it! Google it! 4% is supposed to be the percentage that you can withdraw from your retirement fund and reasonably expect the income to last forever.  On $1 Million dollars, that is only $40,000. And since IRA and 401(k) contributions went in pre-tax, distributions are taxed at ordinary income tax rates coming out. That means you can’t forget to account for the income taxes that must be paid upon withdrawal.  To make things even worse, the “4%” rule is somewhat in dispute after the wild ride the stock market took in the last decade. Many professionals think that the rate should be closer to 3%

Whereas the 4% rule is the safe distribution rate for traditional retirement assets, 8% is the equivelent safe income rate for a maximum over-funded life insurance policy.

The 8%-Rule

Understand that when you take loans against your policy to fund your retirement, your savings “bucket” stays full. Not only does it stay full, but it also continues to grow for as long as you live. Every state has language in its statutes that require insurance companies to make loans to their policy owners. That means that he insurance company must make loans to you that are secured by your cash value collateral. THIS is the magic that makes life insurance so powerful.

Like all loans, the insurance company charges interest. So if you borrow $10,000 at 5% interest, there will be $500 of interest do at the end of the year. What happens is that the insurance company loans you the $500 to pay themselves the interest and they add $500 to your loan balance. They allow you to finance the interest charges.

During each year of retirement, you will continue to borrow money from the insurance company. Each year the insurance company will loan you the money to pay themselves the interest on your entire loan balance. If you have followed this so far, you will realize that you a loan balance that is growing at a compounding rate.

Be mindful that the collateral that is securing the loan is still growing and compounding and is providing 100% collateral for the loan balance! During that first year, in the example above, the $10,000 of cash value that is securing the loan also earned interest or dividends. If the cash value earned 5%, then there was $500 of growth in the cash value… just enough to be collateral for the additional $500 loan to finance the interest.

So as long as the cash value earns at least the same or better than than the loan rate, the policy loans will be secured. Any policy you choose for a LIRP should have what is called a “Wash Loan” feature. This simply means that the loan rate for policy loans will exactly equal the crediting rate on the cash value. Most good policies have this feature.

Now, let’s think about what would happen if the interest rates were different. What if the growth on the cash value exceeds that of the policy loan interest rate?

How can the cash value earn more than the borrowing rate?

Well, if the cash value is growing at a faster rate than the loan balance, then there would be additional cash value that could serve as collateral for loans. If you have more cash value, you can take more income in the form of loans. The ability of the interest crediting strategies in an IUL to capture a portion of the Equity Premium is the reason why we expect the rate of growth on an IUL to exceed the rate of growth of the cash value on a Whole Life.