When planning for retirement, one of the biggest challenges retirees face is market volatility. Sudden downturns in the stock market can severely impact a retiree’s investment portfolio, especially if withdrawals are being made during these periods of decline. However, retirees who include life insurance as a non-correlated asset in their financial strategy can smooth out their income streams and preserve their asset base during market downturns. Here’s how life insurance can play an integral role in stabilizing retirement income.

What Are Non-Correlated Assets?

Non-correlated assets are those whose performance does not directly follow the patterns of traditional investments like stocks, bonds, or real estate. Their value or returns are not tied to market fluctuations, which makes them less volatile during periods of economic uncertainty.

Life insurance products, such as Whole Life or certain types of Universal Life, whose crediting methodologies are more interest-rate sensitive and offer a cash value component, fit this description.

Sequence of Returns Risk: The Threat to Retirement Portfolios

One of the primary financial risks retirees face is the “sequence of returns risk.” This refers to the risk of withdrawing funds from a retirement portfolio during periods of negative market performance. When retirees need to withdraw funds from investments that are declining in value, they sell more assets at lower prices, depleting their portfolio faster than anticipated. This can have a devastating effect on long-term financial sustainability, especially if the market takes time to recover.

By integrating non-correlated assets like life insurance, retirees can mitigate this risk by drawing on a more stable source of funds during market downturns.

Life Insurance as a Non-Correlated Asset

Cash value life insurance provides a unique feature: access to a cash value account that grows tax-deferred over time. When this growth is not directly tied to the stock market, it becomes a reliable source of funds when market investments are underperforming.

Here’s how life insurance can be used effectively during retirement:

Withdraw from Cash Value in a Down Market: When the stock market dips, instead of selling off investments at a loss, retirees can withdraw or borrow against the cash value in their life insurance policies to cover living expenses. This allows their portfolio to recover without the pressure of taking distributions during a downturn.

Preserving the Asset Base: By using life insurance as a bridge during difficult market conditions, retirees avoid drawing down their investment accounts. This strategy helps preserve their asset base, allowing it to rebound when the market eventually recovers.

Tax Advantages: Withdrawals from the cash value of a life insurance policy (up to the amount of premiums paid) are typically tax-free. Moreover, loans against the policy are also not taxed. This provides an additional tax-efficient option for funding retirement without triggering taxable events, especially in years when selling investments might otherwise result in taxable capital gains.

Guaranteed Growth in Some Policies: Permanent life insurance policies, like whole life, often come with guaranteed interest rates or dividends. This provides a predictable source of growth and stability that is unaffected by market volatility. Even in policies such as indexed universal life, the cash value may participate in market gains with a cap but often has a floor, protecting against market losses.

A Complementary Tool in Retirement Planning

Consider a retiree who plans to rely on a 60/40 stock-bond portfolio for income. If the stock market drops by 20% during the first few years of retirement, the retiree could use the cash value from their life insurance policy to fund their living expenses, giving the market time to recover without needing to sell stocks at depressed prices.

By alternating between using market-based assets and non-correlated assets like life insurance, retirees can smooth out the sequence of returns and maintain a more sustainable withdrawal rate.

Life insurance should not be seen as a replacement for a diversified portfolio, but as a complementary tool that provides an additional layer of protection against market downturns. For retirees who have planned well in advance and built-up significant cash value in their life insurance policies, this non-correlated asset can be the difference between running out of money prematurely and enjoying a financially secure retirement.

Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice.  Clients should confer with their qualified legal, tax and accounting advisors as appropriate. 

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