The Retirement Account We Don’t Suggest
When discussing retirement options with a family child care provider recently, they asked why we don’t recommend indexed universal life insurance policies or MPI, Maximum Premium Indexing, accounts. These are accounts that combine life insurance policies with retirement savings. We intentionally exclude these types of accounts as they tend to be a bit weaker in benefits in comparison to other comparable policies.
At first look, these types of accounts seem to be of great value as it is combining two much-needed services – insurance and retirement savings – into one, and who doesn’t like a multi-purpose item? However, upon closer inspection, these accounts actually do neither thing well.
Here are a few drawbacks when considering combining life insurance and retirement savings in a single account:
Higher Costs: Combining life insurance and retirement savings can increase the overall cost of your plan. This is because life insurance policies typically have higher fees and premiums than stand-alone retirement accounts, and a portion of the premiums paid goes toward the cost of the life insurance coverage. MPIs typically have high, hidden fees not only at the start of setting up the account but also on an ongoing basis. In some cases in a down market, these fees can surpass any gains. So you lose part of your investment along the way and the benefits of compound interest. In contrast, the products we suggest typically have no fees at all. (We hate to say they “never” have fees, but we have yet to see a SEP, ROTH, or SIMPLE retirement plan with a fee.)
Lack of Flexibility: Combining life insurance and retirement savings can also limit your flexibility in how these investments work for you. For example, if you need to withdraw money from your account, you may be limited in the amount you can withdraw, or you may have to pay surrender charges or other penalties. While you do have the ability to access your funds, the payouts are much lower than other accounts.
Investment Restrictions: Some life insurance policies that combine insurance and retirement savings may have limited investment options, which could limit your ability to grow your retirement savings. In a good market, you would lose out on compound interest, which is the key generator. In a bad market, there is a lower limit, but the fees can eat into that since the return advertised is “pre-fees”. Additionally, the index only includes value increases, not dividends. Most retirement accounts use age-targeted or other mutual funds that provide a return on increased value and capital gains, but also dividends. This could be a decrease of an average of 2% return. With compound interest, the impact is significant over the life of the investment.
Tax Implications: Life insurance policies with cash value components may have tax implications when you withdraw money from the policy. Withdrawals can be subject to taxes and penalties if they exceed the cost basis of the policy.
Lower Returns: The returns on a life insurance policy may be lower than those on traditional retirement savings accounts such as 401(k)s or IRAs. This is because a portion of the premiums paid goes toward the cost of insurance coverage, which can reduce the amount of money available for investment.
To learn more about retirement plans, check out these resources.
How Do I Choose the Right Retirement Plan?
How Can I Maximize My Savings?
As always, before making a decision, carefully evaluate your options and consult with a financial advisor to determine the best option for your individual circumstances and goals.
