Your clients have worked long and hard their entire adult lives to secure a comfortable retirement, so make certain they don’t make one of the most common mistakes made by a large number of individuals as they contemplate their retirement options.

As they near retirement they’ll set up an appointment with their human resources department, they’ll go over their retirement packet containing three options indicating how much money they can expect to receive each and every month under certain conditions once they retire.

The three options

1. Life only: They can receive the highest monthly income payment guaranteed for the rest of their life if they agree to have the payment end upon their death.

2. Joint and survivor: They can take a reduced percentage payout each month and then have that benefit continue to be paid to their spouse for the rest of their life.

3. Period certain: They can have the payout guaranteed for no less than 10 or 20 years.

Regardless of which of the three options they chose, they have just purchased a Single Premium Immediate Annuity from the insurance company that was accumulating and administratively overseeing the management of the investment assets that were previously in their retirement account. They’ll sign the papers, and their first monthly guaranteed payment will soon begin. Unfortunately, like many of their peers, they’ve just made one of the most common and costly retirement mistakes.

Once a settlement option decision is made, it cannot be changed, so make certain your clients obtain independent assistance. No one has a greater vested interest in their retirement income and the assets that are passed onto the next generation than your client, so guide them to seek professional advice from a knowledgeable professional that you trust. A person that will advise your client of options they probably aren’t aware of. 

An alternative option

For example, what they should have done instead, is take option No. 4, which would entail contacting an independent experienced CFP, CLU familiar with the life insurance annuity marketplace. Your client would provide them with the exact dollar amount in their current retirement account, their and their spouse’s ages, and their personal objectives. The advisor’s assignment would be to do an analysis based on the monthly payout each of those other 10-15 similarly rated insurers that do business in this SPIA marketplace would pay, if their account value was transferred to them instead of to the insurer your employer was going to use. What your client will discover is whether the monthly income payment they were initially quoted by their company’s HR department was in fact the highest payout they could obtain in the open marketplace.

The reason this mistake occurs so often is because in most cases human resource administrators are merely doing what’s easiest for them, which is obtaining a quote from the insurance company they happen to be using for their accumulation and administration services. The primary responsibility of human resource pension administrators is to complete their ERISA fiduciary responsibility and get your client off their payroll. It’s not their job to get them the best payout — that’s your client’s job — and you can certainly remind them of that when it comes to other areas such as their life insurance portfolio that they may also not be as familiar with, as they should be. 

This professional will shop the entire marketplace with the intent of obtaining the best available offer from among many other A+ rated insurers. Once the decision has been made as to which A+ insurer is offering the highest annual payout, the next step is to consider a Roth IRA, or a traditional IRA and open the one that makes the most sense for your client. Then have the funds directly transferred on a trustee-to-trustee basis, which would avoid any taxes and allow the principal to continue to grow tax deferred. 

It’s been my personal experience that shopping the marketplace and doing a direct trustee to trustee transfer to an IRA can often result in a higher monthly payout by as much as 5-6% annually and that’s for the rest of a retiree’s life.

Competition is a wonderful thing if used to your advantage. It’s therefore important that you’re aware of and understand all of your client’s retirement options before they make any of those irreversible retirement decisions.

Some points to keep in mind

An important reason to leave plan funds in the existing employer plan (or roll over to a new company’s plan) is federal creditor protection under ERISA. ERISA plans offer complete protection in bankruptcy and against non-bankruptcy creditors. Once plan funds are rolled over to IRAs, creditor protection is based on state law. 

A significant benefit for clients who are still employed is the ability to delay required minimum distributions. Most company plans allow participants to delay RMDs beyond age 73 until retirement through the “still-working” exception. IRAs offer no such exception.

One downside about leaving funds in the 401(k) is a lack of control, and the plan will not offer as wide an array of investment or estate planning options as IRAs do.

A compelling reason to remain in the company plan is if your portfolio consists of highly appreciated company stock in the 401(k). Doing so will eventually allow the appreciation to be taxed at more favorable long-term capital gain rates rather than as ordinary income, which is how those funds would be taxed if rolled over to and then withdrawn from an IRA.

An IRA rollover often allows for more flexibility, control and options during life as well as at death. There are more customized investment options available within IRAs, and it will be easier to manage their RMDs.

Annuities to supplement retirement income

There are several other highly effective uses of a Single Premium Immediate Annuity to supplement your or your client’s retirement such as diversifying your portfolio by guaranteeing that you receive a set payout regardless of the stock, bond, or interest rate fluctuations for the rest of your life. In addition, a retiree could make deposits to several Single Premium Deferred Annuities over and above their 401, 403 or other retirement/pension deposits to allow these deposits to continue to grow and accumulate on a tax deferred basis. Purchasing several SPDAs while in your forties to fifties allows the annuitant to have these assets continue to accumulate individually and then if or when the retiree wants to increase their income to adjust for inflation, they merely annuitize one of their SPDAs into an SPIA. This strategy gives the annuitant the ability to accumulate retirement assets most efficiently and then when needed, control the flow of their income on a tax preferential basis as there is an exclusionary ratio to offset a percentage of the income they receive.

Recognizing we’re currently experiencing the highest interest rates we’ve seen in two decades, and on the precipice of beginning to anticipate the Federal Reserve soon reducing interest rates, this could be a good time to lock these higher rates in either a SPDA for three to five years, or into an SPIA for an individual’s lifetime 

Life insurance and settlement options

When considering a client’s or your choices one should always consider and evaluate the option of taking the higher, life-only payout and use the difference between that option and the joint and survivor option, net after taxes, to purchase a life insurance contract on the retiree’s life so the income from the death benefit is sufficient to provide an equivalent or greater payout than the joint and survivor option would provide.

The benefit of doing so is that a client may not only able to increase their monthly guaranteed retirement income, but they will also be able to either continue the income from the investment return on the tax-free death benefit proceeds of the life insurance policy on their life to their children at their and their spouse’s passing or give them the balance of the death benefit as a legacy gift. 

Keep in mind that the prime benefit for implementing this option is that the joint and survivor option payout ends at your spouse’s subsequent passing. This combination strategy keeps on giving long after the retiree and their spouse have passed.

To make this strategy even more beneficial to your or a client’s planning, keep in mind that if your client takes the joint and survivor option and your client’s spouse passes before they do, the client would have given up the difference between the two options and never receive the benefit of providing their spouse with continued income. Utilizing the strategy described above would give the client the opportunity to discontinue the premium payment for the life insurance on their life and add the savings of the premium to supplement your client’s retirement income.

Use the correct type of life insurance

When utilizing this or any strategy involving life insurance coverage make certain that your client selects a permanent policy that will guarantee your premium, and death benefit to at least age 92-95, as you don’t want this coverage to expire before they do. Such would be the case if you made the mistake of selecting an association group term, or any term policy when exercising the life insurance and life only payout strategy.

The cost of association group term coverage is considerably less expensive than any other form of life insurance coverage up to age 40-45. But, the association group term premium increases significantly each and every five-year period over age 50 and it becomes exorbitantly expensive at ages 65-75. Further, the coverage gets reduced by 50% at age 75 and expires as do all term policies at age 80. Which accounts for why only 2% of term life insurance policies are ever paid out as a death claim. A money maker for the insurance companies, but not the right strategy for the retiree nor their family. If one wants to maintain life insurance coverage beyond age 80, they would be far better off if they were to consider a 20- or 30-year Guaranteed Fixed Term policy in their 50s or 60s rather than one that increases every five years. Then in the last 10 years of their coverage they should convert a percentage of their death benefit from the term policy into a permanent Guaranteed Universal policy, which should last into their late 80’s or 90’s. Since the cost of life insurance increases each year, the earlier they convert, the less expensive is the cost. One of the most significant benefits of term insurance is the ability to convert to a permanent policy without any medical questions asked.

Plan ahead to enhance your client’s future retirement

If you, or your client, are already maxed out of the allowable contributions to a 401(k) or SEP IRA and still want to supplement their future retirement income, but your or your client’s current income is too high to qualify? You should consider utilizing the tax-deferred accumulation benefits of a high cash value low death benefit type of a life insurance policy instead of a traditional Roth. The reason being that you get all of the tax-deferred benefits of a Roth plus the ability to withdraw the accumulated income on a tax-free basis through a series of surrenders of cash value and loans that never have to be paid back, as long as the life insurance policy survives the insured. Doing so also avoids any RMDs, thus allowing the tax-deferred accumulation to continue for a longer period of time. Lastly, using a life insurance policy to accumulate supplemental assets at retirement rather than a Roth account using mutual funds or other investments, also provides a client’s family the significant benefit of a leveraged tax-free death benefit.

Lastly, advise your clients over age 70 to never let their life insurance expire or turn it into the insurance company for its cash value without first seeing if your client can get a higher payout using an alternate exit strategy called a life settlement, where an individual sells their life insurance policy to an institutional investor through a licensed settlement broker for a significantly higher payout and uses those proceeds to supplement their retirement income.

The point being that you should make your clients aware of all the various options and available alternative strategies that can be used to increase their retirement income as well as provide a lasting legacy for the next generation well before a client turns 50 and certainly well before they make any final decisions regarding their distribution options at retirement.