Why September is the Perfect Month to Address the Risk from Washington

Life Insurance Month & Leg Risk Awareness Month

September brings autumn temperatures, back-to-school vibes, and the return of the pumpkin spice latte

But September also brings together two important observations for any American saver working toward a successful retirement: 

Life Insurance Awareness Month and Legislative Risk Awareness Month

The two observations go hand-in-hand for a good reason: So many of the legislative risks facing savers today can be at least partially mitigated through incorporating life insurance into a holistic retirement approach. 


Understanding Legislative Risk

First, a quick primer on Legislative Risk, and how it can impact your clients in retirement.

Legislative Risk is the risk that Congress passes legislation that changes the rules on a saver’s retirement approach or retirement assets. This could impact savings vehicles themselves, or how those vehicles are taxed and structured. In short, it is the risk that Congress changes what is taxed, when it is taxed, and for whom it is taxed.

We just experienced a good example of Legislative Risk in 2019. In the Secure Act, Congress included a provision eliminating the Stretch IRA for most Americans, requiring most savers who inherit a retirement account to drain the account within 10 years. This change impacted when inherited IRAs are taxed, potentially upending tax strategies IRA owners had put in place for their heirs.

Legislative Risk goes hand-in-hand with Tax Risk, which is the risk that a saver’s taxes are higher in retirement than planned. Together, Tax and Legislative Risk underscore how retirees could end up sending more of their retirement income to the IRS as taxes, thereby leaving them with less retirement income to spend on living expenses. 

So why is Life Insurance Awareness Month so important to helping our clients address Legislative Risk? 

There are many ways life insurance can help U.S. savers mitigate Legislative Risk (and more could be coming with some of the proposals being discussed on the campaign trail). But for today, I want to focus specifically on one important way cash value life insurance can help protect savers from legislative changes impacting 401(k)s, IRAs… and even Roth accounts.


Account vs. Contract

American savers are starting to understand the importance of tax-free assets in retirement. After all, if their taxes are higher in retirement than planned - which is a real risk, based on what’s happening in Washington these days - they need a hedge against those rising rates to protect the level of retirement income they can generate.

This has led many savers to convert a portion of their tax-deferred funds into tax-free accounts, like Roth IRAs and Roth 401(k)s. 

And that’s a good thing! Diversifying the tax status of a client’s retirement assets is an important first step toward addressing the risk of rising taxes in retirement. 

But for many savers, it may not be enough. 

Advisor Facing Legislative Risk Memo First Page Graphic with Drop ShadowOver the past few years, we’ve seen Congress debate multiple pieces of legislation that could change how IRAs and 401(k)s are taxed for some savers. And some of those proposals impacted Roth accounts, too. (You can download my analysis of these efforts here.) 

 

If these changes are passed, savers could find themselves accessing their retirement assets under an entirely different set of rules than they saved them under.

Here’s why:

IRAs, 401(k)s and even their Roth counterparts are all accounts. When Congress passes new laws impacting accounts, those laws take immediate effect on both accounts established in the future AND accounts already in existence today. 

So, the contribution, distribution, and tax rules can constantly change for IRAs and Roth IRAs.

This means the legislative risk surrounding these retirement accounts is high: Congress can change the rules, and those rules impact everyone with one of those accounts.

But life insurance is different - and that includes both savings-oriented life insurance, like IUL, and max-death-benefit-focused life insurance, like GUL

Funds in a life insurance policy are housed in a contract, not an account. 

And contracts have a very different legislative risk profile. 

The courts have generally upheld that when Congress changes the rules on a contract, those rules can be applied to new contracts going forward but can NOT be applied retroactively to contracts already in place. 

We saw this play out in the 1980s and 1990s with Congressional reforms like TAMRA and TEFRA. Legislation made adjustments to the tax status of certain cash value life insurance policies, but only for policies going forward. The policies already in place continued to operate under the old rules. (For example, a pre-TEFRA life insurance policy could be a MEC, but not incur any of the tax requirements the bill established for MEC policies going forward.)

This one small difference can have a big impact on your client’s retirement assets in a rising tax environment. They can feel confident the rules they’ve saved under in a cash-value life insurance policy will be the rules they access their funds under in retirement. 


How You Can Help

With Life Insurance Awareness Month and Legislative Risk Awareness Month both taking place right now, September is the perfect time to help your clients evaluate if cash-value life insurance could help protect them from the risks coming from Washington. Here are three of my favorite resources to help you do it: 

  1. Election Preview Webinar - Join me next week as I discuss the election and how it could impact your client’s retirement approaches. Register here

  2. Retirement Tax Bill - Let your clients see their potential tax bill in retirement - and evaluate options to reduce it

  3. Washington & Your Clients - Use this brochure to help your clients understand how the decisions in Washington could impact their retirement