Creating the "Wealth Effect"

Creating the "Wealth Effect"

By Tom Wall, Ph.D., MBA, MSFS, CLU, ChFC

Imagine this: you've just found out that a relative has left you a substantial sum in their will. You will begin receiving substantial distributions in 10 years. Suddenly, your financial future looks a whole lot brighter. You start dreaming of all the things you'll do with that money - the trips you'll take, the home renovations you'll make, the retirement lifestyle you'll finally be able to afford.

Anticipated financial windfalls such as deferred lottery payouts, substantial bonuses, or expected inheritances can significantly influence an individual's spending and saving behaviors today. The psychological impact of knowing a substantial sum of money is on the horizon often leads to what economists call the "wealth effect," where individuals feel wealthier and may increase their spending or make larger investments even before receiving the funds or capitalizing appreciated assets. This effect can have profound impacts on one's peace of mind, confidence, and overall happiness when properly managed.

The Wealth Effect of Whole Life Insurance

Whole life insurance pays out WHEN you die, not only IF you die like term insurance. This inevitable gain for one's estate, coupled with the cash reserves inherent in the policy, make it a backstop for spending from volatile investments. It serves multiple strategic purposes: legacy planning, addressing long-term care costs, providing liquidity, and complementing longevity planning when paired with an annuity. These risks or goals can be boiled down into the 4 "Ls" of retirement income planning.

Legacy Goals

Whole life insurance is a powerful tool for legacy planning. The death benefit provides a guaranteed sum to beneficiaries income tax-free.  This ensures that legacy goals are met regardless of other financial outcomes or remaining retirement assets.

Long-Term Care Costs 

As healthcare costs continue to rise, planning for long-term care becomes crucial. Whole life insurance policies can often include riders that allow policyholders to access part of the death benefit for long-term care expenses, providing financial relief when needed most without completely depleting other retirement funds.

Liquidity Preference

One of the distinctive features of whole life insurance is its cash value component, which grows over time and can be borrowed against. This provides a liquidity option for policyholders, which is especially useful if other assets are tied up or depressed in value due to market swings, ensuring that financial needs or opportunities can be met without sacrificing investment positions.

Longevity Planning with Annuities

Annuities are a popular choice for managing longevity risk as they provide a steady income stream until death. However, one downside is the lack of liquidity and the fact that invested capital in an annuity is generally not passed on to heirs upon death. Here, whole life insurance complements an annuity by providing a death benefit that can cover the financial legacy that the annuity cannot.

David Blanchett and Michael Finke published a paper titled “Guaranteed Income: A License to Spend,” which discussed how retirees with pensions or guaranteed sources of income spend more than people with invested assets of similar economic value. Including whole life insurance in your clients’ retirement plans may give them the comfort to annuitize their assets and obtain a better lifestyle in their golden years.