Life Insurance As Part Of Retirement Planning
When it comes to retirement, the value of permanent life insurance isnt always considered. By having the right life insurance coverage when you retire, you can make it easier for your family to handle finances when you die. Coverage from a permanent life insurance policy can also help protect your money, manage your taxes and give you the opportunity to grow cash value which you can use for a variety of needs and activities.
The Basics Of Term Life Insurance
The least expensive type of life insurance, considering not just out-of-pocket costs but also the amount of coverage you get for the money, is term life . It guarantees payment of a stated death benefit during a specified termsuch as 10, 20, or 30 yearsbut has no cash value component. When the term expires, the policyholder can either renew for another term, convert to permanent coverage, or allow the policy to terminate.
Life insurance prices vary depending on a person’s age, health, and other factors. For example, a nonsmoking 35-year-old man in good health might be able to get a 20-year term policy with a $1 million death benefit for $1,030 or so per year. If the same man bought a whole life policy, a type of permanent life insurance, the premium might be $13,500 or more annually for the same death benefit.
Given these costs, term life insurance can be a useful retirement savings tool in two ways. First, it provides the basic financial protection a family will need if one of the breadwinners dies before accumulating enough savings for the family to live on. Second, the relatively low price frees up more disposable income to use for other purposes.
Given the lower premiums associated with the policy, investors will have more to invest for retirement, college, or other financial goals,” says in Irvine, California, and author of Index Funds: The 12-Step Recovery Program for Active Investors.
Is The Life Insurance Cost Worth The Tax Savings
Though life insurance is an expensive fee vehicle, the opportunity for the cost to be worth the tax savings is greater today than it has been for decades. Thats because of the Consolidated Appropriations Act, 2021.
The Consolidated Appropriations Act, 2021 changed the tax code rule under IRC Section 7702 such that the key interest rates for permanent and long-term life insurance policies went from 4% to 2%. This is a recalculation based on todays historic low interest rates and the high percentage of long-term insurance holders. The law went into effect on January 1, 2021.
Before this change, these rates hadnt been revisited and adjusted for over 35 years.
This adjustment also keeps the life insurance plan from being categorized as a modified endowment contract. With modified endowment contracts, the IRS can tax the plan like an annuity if you put too much money in it.
Under the new interest rate, you can put more money in your life insurance than before without violating IRS modified endowment contract rules, and thus, without IRS penalty.
As the death benefit is based on the interest rate, and the insurance cost is based on the death benefit, this adjustment creates a higher savings and tax efficient opportunity. Consumers get lower-cost permanent life insurance policies that look and feel like Roth IRAs, and, if designed appropriately, the cash in the contract can grow tax deferred and be taken out tax-free.
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You Have An Increasing Projected Financial Loss If
You plan to continue increasing your income during retirement, such as if you own a business or have a high net worth. In other words, your beneficiaries would experience much more of a financial loss if you pass after retirement compared to if you pass before retirement.
If you have an increasing projected financial loss, you’ll likely want to provide for your beneficiaries through permanent life insurance in case your death would eliminate the increasing income you plan to provide even into retirement. Permanent life insurance may also help offset the cost of estate taxes that will come out of your estate before it gets passed on to your loved ones but you should consult your tax advisor to understand any tax implications for your particular circumstances.
Regardless of your projected financial loss, a permanent policy also makes sense if you want to ensure your death benefit will be paid out no matter when you die. With a term policy, you’re only covered for a specific number of years. Learn more about how types of life insurance differ.
Using Cash Value Life Insurance For Retirement Income
For many financial professionals helping clients plan for a life in retirement, life insurance policies represent another potential tool in guaranteeing retirement income. However, correctly leveraging cash-value insurance policies requires a careful financial planning checklist and a lot of personal follow-ups.
Retirement Income Center co-director Steve Parrish lays out what kind of retirement life insurance plans he recommends in this piece from the Retirement Income Journal.
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Protection During Market Fluctuations
Equity investment and retirement account values do fluctuate, which can cause issues if you are relying on them as your income stream during retirement. If you withdraw money from an equity-based retirement plan during a downturn in the market, the amount of principal that future returns will be based on will decrease. Having a substantial amount of cash value from a whole life insurance policy can help support you financially in the event of a volatile economic market.
Using Whole Life Insurance For Retirement
One of the most valuable advantages of whole life insurance is that it builds cash value that can be used later in life for important financial purposes, including retirement.1,2 But are whole life insurance policies really a good option for that purpose? This article can help you decide by answering the following questions:
- What are the benefits of whole life insurance and using it to supplement retirement?
- Who should consider using whole life insurance as part of their retirement strategy?
- What are the disadvantages of using whole life insurance in retirement?
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Three: Create Another Source Of Income Especially For Retirement
As you go through life, youll probably have some large expenses, such as paying for your kids or grandkids college educations, the mortgage, or a major emergency. You may also want to supplement your retirement incomeanother large expense.
Over time, many offer you the potential to accumulate cash value. It can be used any way you wish,1 including as , through tax-advantaged loans from your policys cash value. Indexed and variable permanent policies are often used as part of an income strategy.
Using Life Insurance To Fund Retirement
Building cash value
One of the benefits of a permanent life policy is the ability to accrue cash value. In its simplest form, the cash value within a policy is the balance remaining after a portion of a premium payment is applied to insurance costs. It is this feature that provides a few different uses for life insurance in retirement.
Using life insurance for retirement income
As the Simple Dollar explains, the cash-value account grows over time and can be withdrawn as a source of income in retirement. And provided the amount withdrawn doesnt exceed the amount youve paid in premiums, its not subject to taxes either.1
Borrowing from yourself
You can also use life insurance for retirement by borrowing from your cash value. Think of it as a loan youre getting from your future self. Technically, youre not required to re-pay it, although it will accrue interest and ultimately, the loan amount will be deducted from the death benefit .
Paying your policy with your policy
If youre reassessing your budget items in prepping for retirement, another thing worth noting for permanent life policyholders is the ability to pay upcoming policy premiums with your cash value.
What about term?
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Using Life Insurance To Pay For Retirement
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For many people, life insurance and retirement planning are two separate things. Retirement planning is for you, and life insurance is for your beneficiaries. However, some financial advisors also recommend life insurance as one way to plan for retirement.
Because of the costs involved, this strategy is controversial but there can be upsides, if youre a good fit.
Building Cash Value Through Life Insurance
Not every life insurance policy can be used as part of a retirement plan. If youre able to do so, it will be because the policy has accumulated cash value. Accumulation occurs when the premium you pay is split three ways: your insurance companys operating costs, your policys death benefit, and the cash value.
Your insurance company will invest the money you put toward your policys cash value, and you can expect it to grow slowly. The investment will likely be on the conservative side, meaning that its low-risk, low-reward, and youll avoid the worst of any market volatility. If youre counting on the cash value to pay for your retirement, thats precisely what you want.
There are two basic types of insurance that can be broken down into further subcategories. Not all of them are suitable for cash value accumulation. For the types that are, results will vary.
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A Quick Overview Of Policy Loans
Another key advantage to IUL policies is their loan provisions. Once you have built up adequate cash value in your policy, you can borrow from the policy on a tax-free basis. You dont have to repay it if your cash-flow doesnt accommodate this. Interest will be charged on the loan, and if the loan isnt repaid, it will be deducted from the death benefit proceeds.
For example, say someone has an IUL policy with $100,000 of cash value built up inside it. Then they take out a loan for $40,000 to buy a new car or make improvements on their home.
If they passed away soon afterward, then their beneficiary would receive a reduced death benefit. But you wont pay a 10% early withdrawal penalty on your withdrawal if you are under age 59.5 like you would with an IRA or a qualified plan. There is no age limit for taking money from the cash value as there is with most retirement savings accounts.
Buffer Market Volatility With Permanent Life Insurance
Qualified retirement savings accounts, such as 401 and IRAs can be helpful tools for building up assets for retirement. But, when it comes time to get money for retirement, it involves selling off shares of the investments.
When the market is doing well, that’s no problem. But if the market is down, you may be selling more shares of your investments than you want in order to get the same income you need. That also means you may be depleting your account too quickly, and jeopardizing your future retirement income security.
Most permanent life insurance policies have the ability to build up cash value. While there are different types of permanent life insurance, many have protections in place that shield the cash value from market volatility. That means you can potentially use this asset for retirement expenses during investment downturns and allow your investment accounts to rebound in value.
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Other Tips To Help Pay For Retirement
There is more you can do than just buying a long-term life insurance policy and converting it into an annuity. While thats a great way to build up your cash value and turn that into a monthly income, there are other ways to save up or receive the income you want during your golden years to enjoy the life youve earned. Some other things you can do are:
- Create an Emergency Fund: Consider having an emergency fund so that you can use your income how youd like to without worrying about the unexpected. An emergency fund pads your total cash on hand in case you run into any troubles and you can even earn a little on that money with a high-yield savings account.
- Long-Term Disability Insurance: If you become unable to work because of a disability then this type of insurance can provide you with your lost income. It protects you from having to retire too early due to an accident or permanent disability.
- Max Out Your Retirement Account: Theres no time to prepare for the future like the present. Max out both your 401 and your personal retirement accounts so that you can have the amount you need when it comes time to retire.
The key to paying for retirement is preparing as quickly as you can. If you dont feel adequately prepared you can speak to a financial advisor who can help set up a plan to get you where you want to be and have the money you need to retire comfortably.
Take Money Against The Cash Value
When you pass away, your dependents receive the money, but they do not receive the cash value. That is why you should use the cash value in your lifetime. You can borrow against the cash value and repay the amount you owe. However, you can only do this if the amount you borrow with interest does not surpass the cash leftover in the insurance coverage.
If you are thinking of borrowing against the cash value, you need to understand the concept of phantom income. You will be charged a huge tax amount if you end your insurance coverage and the amount you borrowed equals your cash value. They will tax you on the amount that surpassed the premiums you paid off.
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Indexed Universal Life Vs 401 For Retirement Planning
- Explore the merits of an IUL vs. 401 for retirement saving. Learn how each product works and how it affects taxes, access to cash and growth potential.
Indexed universal life insurance and 401 plans are two common ways to save for retirement but which is best for you? As you weigh the pros and cons of IUL vs. 401 plans, it’s helpful to consider your current financial situation and future goals.
One: Provide Money To Help The People You Love
You work hard to provide for the people you love, seeing to it they have what they need. But what will happen to them when you die? Think about how theyll be able to pay for such things as your final expenses, debt, the mortgage, care of a child, or a college education for your kids or grandkids.
Life insurance provides them with a sum of money, known as a death benefit. In general, a can help you to meet these needs. If you want a longer-lasting policy, take a look at a .
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Should You Use Life Insurance In Your Tax Strategies
Using life insurance for tax-free income can be beneficial as part of an overall tax planning strategy. Index universal life insurance is popular among high-income taxpayers in many cases because of their ingrained tax advantages. However, growing numbers of other policyholders are also finding value in it.
You might be inclined to explore other permanent life insurance, such as whole life insurance, for your tax planning mix. But, overall, is this strategy for you? Who would be a good candidate for using life insurance in a tax planning strategy?
Those who are in their mid-career and have consistent income earnings per year are one. Since the cash value takes time to grow, its important to have a long enough timeline for that before retirement. You also want to be able to keep up the premium payments over the years so your cash value can grow.
Your financial professional can walk you through the pros and cons, as well as other details relating to your situation. Dont hesitate to ask questions or seek clarity if something doesnt make sense. This is your money, and you want it to work well for you now and in retirement.
Use Whole Life To Diversify Your Retirement Income Sources
You may have heard someone mention or read somewhere else online that you should plan to withdraw no more than 4% of your assets in retirement? This is whats commonly referred to as the 4% rule.
Theres a lot of common financial wisdom floating around out there and one of the favorites relates to the 4% rule. People will suggest that if you just follow the 4% rule everything will work out fine.
After all, average market index returns have far exceeded that and despite the up and down, if you keep withdrawals to no more than 4% youll be fine.
The idea is that it will ensure you against running out of money over time as you take the money that you need to live from your total pool of liquidity in retirement. It was conceived by William Bengen back in 1994 and further analyzed by three professors at Trinity University in what has become known as the Trinity Study.
This has led a lot of financial professionals to recommend a plan where individuals liquidate no more than 4% of total assets in any given year to cover retirement expenses. And theres a lot of hypothetical data to support it, just google it, youll not run out of reading any time soon.
Maybe it will work out for some people but our suspicion is that its way oversimplified and really doesnt account for at least two separate risks :
1. That there could be a significant drawdown in your investment account during the early years of your retirement income phase of life.
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