The concept of using life insurance to supplement retirement might seem foreign, but permanent life insurance cash value accounts can offer a variety of advantages in retirement.
Under current tax codes life insurance cash values grow tax deferred and policy loans are tax free and do not have to be repaid as long as the policy remains in force until the insured’s death. A properly structured life insurance policy provides a tax-free death benefit as well as a tax advantaged retirement income stream, and should be considered in an overall holistic financial plan.
Contributing to a Roth IRA/401k and maximum funded permanent life insurance are ways to hedge against higher tax rates in the future because the distribution from these types of accounts are generally tax-free. One advantage of permanent life insurance over Roth accounts has to do with contribution limits. In a life insurance contract the maximum death benefit an insured can qualify determines how much they can contribute to the policy.
For example, a 40-year-old male who makes $100,000 per year can usually qualify for a death benefit in the amount of twenty-five times their income ($2,500,000). This death benefit allows a contribution in the ballpark of $100,000 without losing it tax advantages, whereas contributions to Roth accounts are much lower.
Furthermore, incomes restrictions eliminate some high-income earners from contributing to Roth accounts which makes permanent life insurance a viable option. Another advantage of life insurance over Roth accounts is the ability to access the account value before age 59 ½ without incurring a premature withdrawal penalty.
Permanent life insurance can be one of the most versatile retirement tools available because the owner controls the contribution and distribution of the account value.
Life insurance cash value can be used as collateral for multiple kinds of loans, making it one of the most versatile retirement tools available.
In most states permanent life insurance cash values are protected up to certain limits from creditors and bankruptcy which can create a level of asset protection. For example, doctors and attorneys frequently maximize life insurance contributions in order to protect themselves financially from frivolous lawsuits.
Permanent life insurance cash values can establish a sense of security during the working years and produce a great source of income throughout retirement.
Before diving head first into a life insurance policy, it’s important that you have a full understanding of what you’re getting yourself into.
Depending on the structure of your policy and the wealth accumulation strategy that goes along with it, there may be real risks associated with improper execution.
Overfund your policy and you might transform it into a “modified endowment contract”, which will lose many of the tax advantages your policy was set up for in the first place. Or, if your policy lapses with outstanding loans, you’ll be taxed on everything over the amount you put into the policy.
Also, while the overall fees in a life coverage contract are generally much less than a managed account in the long run, the fees are front loaded into the policy making it a poor short term strategy. If short term liquidity is the goal, a client will often be better served by “buying term and investing the difference.”
Life insurance is hands-down the best way to provide financial security for your family. However, if you choose a plan for a reason other than the death benefit, make sure that you are certain you understand and can execute on the strategy behind your maximum funded life coverage policy.