Life Insurance for Retirement Planning

You might not know it, but permanent life insurance is often used in retirement planning.  Permanent life insurance, specifically universal life insurance, can be a valuable cash accumulation vehicle and offer a steady stream of tax-free income in your retirement.  The key to maximizing the cash value growth is facilitated by structuring the policy in a specific manner.  We are going to discuss the basics of the strategy and its tax advantages and flexibility.

How Does The Strategy Work?

Traditionally, permanent life insurance is usually set up to give you the maximum death benefit for the smallest premium.  Over time you should slowly build cash value that you can access in the future.  Using your premium to pay for the highest amount of death benefit will require quite some time to grow substantial cash value. The higher death benefit means that your cost of insurance will be higher.  Let’s say that instead of paying the lowest premium for the highest amount of death benefit, you paid the highest premium for the lowest amount of death benefit allowable by the IRS? Because you are lowering your death benefit amount, you are essentially lowering the cost of insurance.  The lower cost of insurance coupled with the higher premium allows for faster cash value growth.  The key to the strategy is to deemphasize the death benefit and emphasize cash value growth. If your focus is the highest possible death benefit that lasts your entire life, this strategy is not for you.

At one point, many were abusing this strategy to take advantage of the tax benefits. The IRS considered these policies investments masquerading as life insurance.  They decided to set guidelines for the minimum death benefit in a policy as it relates to the aggregate premium paid and guidelines for how quickly you could fully fund a policy.  Life insurance illustration software today allows your agent to create an illustration utilizing this strategy and keeping within the limits allowable by the IRS.  Using this strategy, the death benefit should rise over time as the cash value increases to keep it within the guidelines mentioned above.  What if it is not set up properly and you violate these guidelines? Your policy will lose many of the tax benefits that were intended.

Using the Cash value for an Income Stream

Since this is used as a supplemental retirement vehicle, you can treat the contributions as such.  You must decide how much more you could comfortably save yearly in after tax contributions in addition to your other current retirement plans. That is the amount you would pay as your premium each year.  Once you hit retirement age, you stop making premium payments. You then start taking money out of the policy in the form of policy loans that are paid back with the death benefit when you die.  A whole other blog post could be written on policy loans, so we won’t go into too much detail here.  The thing to remember about loans is that even though you are charged interest on the money you pull out, the insurance company still credits that amount with interest as if you did not take it out.  In many cases, it is simply a wash loan.  That is, you are credited on the money you borrow at the same interest rate that you are charged. Most companies require you to keep your policy in force for a specific number of years until you can potentially take advantage of a wash loan.

 Who Is This Strategy Best Suited For?

This strategy is not for everyone.  You should utilize a Roth or Traditional IRA before looking at a strategy like this for retirement savings if your income allows.  This strategy is beneficial for high earners who are maximizing their 401k contribution and their income level prohibits them from being able to contribute to an IRA.  It can also be a valuable planning tool for those who think taxes will be substantially higher in the future.

Tax Advantages and Flexibility

The point of this strategy is to utilize the tax deferred growth with tax free income potential that permanent life insurance provides.  But there are other advantages as well.  There is no 59 ½ or 70 ½ rule that you must adhere to for life insurance withdrawals like there are in other retirement accounts like a traditional IRA or 401k.   Also, any funds that you take out of your insurance policy while you are collecting social security will not count toward provisional income.  This could reduce the amount of your social security benefit that is taxed.

You can also add riders to enhance policy benefits.  One example is a long term care rider where your policy will be used to pay for qualified long term care costs.  The amount paid will reduce the death benefit, but your policy will not only have retirement income benefits but also long term care benefits as well.  Another example is an overloan protection rider.  This will prevent the policyholder from borrowing too much from the policy and forcing the policy to lapse, thus creating a taxable event.

Disadvantages of the Strategy

With this strategy there is always the cost of insurance to consider.  Even though the strategy calls for a lower death benefit, the cost of insurance is an additional cost.  You should determine if the tax benefits will ultimately outweigh the costs of the strategy.  Surrender charges are also an issue if you walk away from the strategy early on.  Depending on how early you walk away, you could wind up with little or nothing compared to what you paid in.  You should also consider that letting the policy lapse after pulling out a substantial amount of cash could lead to a taxable event.

What Is the Best Product to Use?

Universal life insurance is an excellent product to use for this strategy.  It allows flexibility that other permanent products do not have.  There are a few universal life products to choose from and the one that is best for you will really depend on your risk tolerance.

Conclusion

This post is simply meant to give a basic explanation of the strategy and its benefits and nothing more.  Before you consider using this strategy as part of your financial plan, make sure you talk to an agent who can thoroughly explain the strategy to you. Because of the lower death benefit used in this strategy, you should consider supplemental term coverage so that you are not underinsured.  You should also consult your tax advisor about the potential tax issues that could arise if not used properly.  We would be happy to show you how this strategy could benefit you.  Please feel free to give us a call at (888) 687-9444 or email us at info@archstoneagency.com if you have any questions.

Archstone Insurance Services, LLC is an independent agency that shops over 40 of the top life insurance carriers to provide huge savings on life insurance coverage for our clients.  We are happy to answer any questions you might have about any of the insurance products we offer, your planning needs or your existing coverage.  Feel free to call us directly at (888) 687-9444 or email us at info@archstoneagency.com.  You can also visit our website at www.archstoneinsurance.com.