Using Life Insurance to Help With Retirement Savings

Whole-life and universal life insurance policies with an investment or savings component can often be useful retirement tools. Policies with sizable cash values have the potential to generate income in retirement, with the money growing tax-deferred. However, your main source of retirement funds should be specialized retirement accounts like 401(k)s and IRAs.

Cash Value Exempt from Taxes

Investments made in retirement accounts, like an IRA or 401(k), do not incur taxes on the growth of life insurance cash values. Additionally, they are shielded from the fluctuations in the market that may affect other accounts. You can borrow against or take from the cash worth of your whole life policy without paying income taxes if it is set up as a modified endowment contract (as long as you don't exceed the amount of premiums you paid). Another option is to perform a 1035 exchange, which would allow you to exchange your life insurance for an annuity that pays you back principal plus interest on a regular basis. For people who have already maxed out their other tax-advantaged retirement savings and investing accounts, this is an alternative that might be helpful. It's crucial to keep in mind, though, that this tactic may lessen the death benefit your loved ones obtain. If you choose to do this, make sure you speak with a financial expert beforehand before making any adjustments. Additionally, you should review your need for life insurance protection once a year or following any significant occurrences that can impact your need for coverage.

Benefits of Tax-Free Death

Life insurance can help you achieve your goals in a tax-efficient manner, whether you're searching for legacy protection, financial security against a major health crisis, or additional retirement income. Permanent policy premiums are not deductible, but the cash value of the policy may increase tax-deferred. You may be protected from market volatility and earn an investment-grade return, depending on the policy type and features. Any money above the cash basis of your insurance that you surrender will be taxed as ordinary income. In a similar vein, any outstanding loan balances and related interest are deducted from the death benefit your beneficiaries receive when you borrow against the cash value of your life insurance policy.

Tax-Exempt Bequest

Specialized permanent life insurance plans, known as Life Insurance Retirement Plans (LIRPs), have the potential to generate income in retirement. High-income earners who are supplementing their retirement funding plan with LIRPs are the perfect fit for those who are contributing to standard retirement savings vehicles like 401(k)s and IRAs. A whole-life or permanent policy that accrues cash value over time is used in LIRPs. The retirement income stream is then derived from this amount. In retirement, the income generated is taxable, but it might not be as high as it would be from other investments. One advantage of LIRPs is that the income they give your estate's beneficiaries is tax-free. This implies that in Iowa, inheritance taxes—which vary from 2% to 6% of the death benefit—do not apply to members of your immediate family, which includes your spouse, kids, grandkids, and siblings. Another effective strategy to reduce estate taxes is to use LIRPs. However, if you take out a loan against the cash value, the death benefit your beneficiary will receive will be reduced by the interest you must pay on that amount.

Income Exempt from Taxes

Many whole life insurance policies have a cash-value component, but a 401(k) or an IRA may offer greater savings potential because of compounding investment profits and employer contribution matching. You are not required to pay taxes on any amount you withdraw or borrow from the cash value of your insurance when you retire, up to the full amount of premiums you paid. Nevertheless, the death benefit your heirs receive will be reduced by the amount of any unpaid loan balance. Another function of whole life insurance is as a "forced savings account." The premium is payable each month, much like with funding a 401(k) or IRA. By doing this, the money is kept invested and over time, the monetary value increases.