Using Life Insurance for Retirement Income

Retirement planning traditionally relies on common savings vehicles like 401(k)s, IRAs, and brokerage accounts. However, one frequently overlooked option that can provide additional flexibility and tax efficiency is permanent life insurance. Here, we’ll discuss how permanent life insurance works, why it’s beneficial for retirement planning, and important considerations for determining if it’s suitable for your financial strategy.

What Is Permanent Life Insurance?

Permanent life insurance differs significantly from term life insurance, as it remains active throughout your lifetime, provided you pay premiums. Common types include:

• Whole Life Insurance: Features guaranteed fixed premiums, death benefit, and steady, guaranteed cash value accumulation.
• Universal Life Insurance: Offers flexible premiums and death benefits, with cash value growth dependent on interest rates or underlying investments.

Understanding Life Insurance Cash Values

Each premium you pay into a permanent life insurance policy covers two components: the cost of insurance (covering risk and administrative costs) and cash value accumulation. Over time, the cash value grows on a tax-deferred basis, meaning you don’t pay annual taxes on this growth. Initially modest, cash value growth accelerates over many years, eventually becoming a substantial asset within the policy.

Utilizing Cash Value for Retirement Income

In retirement, your accumulated cash value becomes accessible through two main methods:

• Policy Loans: Loans from your cash value are tax-free, assuming the policy stays in force. Interest rates on these loans are usually competitive and can often be repaid via ongoing premiums or deducted from the death benefit.
• Withdrawals: You can withdraw up to the amount you’ve paid in premiums (your basis) tax-free. Amounts beyond that will be taxed as ordinary income.

Strategically combining loans and withdrawals can offer tax-efficient supplemental retirement income, especially valuable during low-income or tax-sensitive retirement years.

Advantages of Using Life Insurance

Permanent life insurance has notable benefits for retirement planning. Its tax-deferred growth allows your money to compound efficiently, while the ability to access funds tax-free via loans or basis withdrawals provides valuable flexibility. Additionally, unlike traditional retirement accounts, permanent life insurance isn’t subject to penalties for early withdrawals before age 59½.

Furthermore, permanent policies guarantee a tax-free death benefit, serving as a crucial element in estate and legacy planning. Whole life policies specifically offer guaranteed cash-value growth, protecting your retirement plan from market volatility. Lastly, the liquidity offered by the cash value allows you to address unforeseen expenses, such as long-term care, without tapping into taxable retirement accounts.

Considerations and Potential Drawbacks

Despite these advantages, permanent life insurance has important drawbacks. Premiums can be significantly higher, often two to four times those of term policies, partly due to commissions, fees, and higher administrative costs. Additionally, permanent life policies, particularly variable universal life insurance, can be complex, requiring active management to ensure they perform as intended.

Policies often come with surrender charges if canceled early, significantly reducing your cash value if you discontinue the policy prematurely. Interest-rate risk is also notable, particularly with universal life policies. If credited interest rates fall, maintaining your policy may require additional premiums, affecting your retirement strategy’s predictability and stability.

Determining if Permanent Life Insurance Fits Your Strategy

Permanent life insurance generally suits those who:

• Maximize traditional retirement accounts and seek additional tax-efficient growth.
• Value a guaranteed death benefit for legacy or estate planning.
• Are comfortable with paying higher premiums when compared to traditional term life insurance.

It may be less suitable if you’re looking for maximum market returns or prefer simpler retirement vehicles with lower associated costs.

Example: Permanent Life Insurance in Action

Sarah, age 45, invests $12,000 annually in an indexed universal life insurance policy for 15 years. By age 60, her cash value grows to over $200,000. In retirement, Sarah supplements her pension by withdrawing $10,000 annually via tax-free policy loans. By strategically accessing these funds, Sarah reduces her tax burden compared to withdrawals from a traditional retirement account. Upon her passing, the outstanding loan reduces the death benefit, yet her heirs still receive a meaningful, tax-free inheritance.

Getting Started

To determine if permanent life insurance aligns with your retirement goals, reach out to one of our consultants. They will help you evaluate different policy options, carefully review illustrations to understand potential outcomes, and regularly reassess policy performance to adjust as needed.