Using a hypothetical investment, calculate the capital equivalent value of the cash flows generation potential of a cash value life insurance policy. |
Let's assume you have a set amount of money available that you can contribute to an asset over a fixed time frame. You then put this money into any hypothetical investment. We'll initially assume it offers tax-free distributions. When you retire, you would then expect this investment to supply your retirement income. Generally, the safe withdrawal rate for any investment is considered to be between 2.8% and 4%. A 2.8% distribution rate has about a 99% confidence level of not running out money before you run out of life. A 4% distribution rate has about a 93% chance. Another option would be to use these dollars to fund a cash value life insurance contract. Doing so creates a similar box called cash value. We can then project the value of what your premiums and dividends would grow to by your age 100. Which we will consider to be the contract's expected death benefit. In the future, thanks to the power of uninterrupted compound interest, you're able to start spending your death benefit before you die by taking loans against the policy - which are tax exempt. The hypothetical investment would need to generate the same income after taxes. How confident do you want to be that your distribution strategy succeeds? Consider this... if you were taking a plane flight and the pilot said you have a 93% chance of landing at your destination, would you get on that plane? Probably not. Similarly, choosing a 4% SWR (with its 93% confidence level) may be a more aggressive withdrawal rate than many are comfortable with - but ultimately, its for you to decide. With this information, we can calculate the hypothetical investment balance (Capital Equivalent Value) necessary to fund the desired retirement distributions at the safe withdrawal rate using the following formula: Capital Equivalent Value = Annual Withdrawal / Safe Withdrawal Rate Substituting in the numbers we see the value of the hypothetical investment must grow to this amount. Let's see how feasible this is. We can use a time value of money calculation to determine the rate of return necessary to achieve this amount. You would need to earn this (xxx) rate of return every year throughout the entire accumulation period. Have you achieved this rate of return each year in your investment experience to date? Also, if you need to pay taxes on your distributions, the growth requirements would be even higher. Lastly, let's consider the effects on income-based benefits like Social Security. Unlike policy loans, you may need to pay taxes on your benefits if the hypothetical investment increases provisional income. Doing so will require a larger annual withdrawal to achieve the same net income - consequently impacting the Capital Equivalent Value and associated CEV ROR required to achieve the same retirement distribution as the cash value insurance contract. |
Capital Equivalent Value = Annual Withdrawal / Safe Withdrawal Rate CEV ROR = TVM RATE(Periods=10, Payment=$100,000, PV=0, FV=$1,857,143) (using default example values. Substitute your values if you deviated from the example.) |