Using Life Insurance to Pay for Retirement

Permanent life policies can supplement retirement savings, but consider other options first.
Alice Holbrook
By Alice Holbrook 

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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 you’re a good fit.

Permanent life insurance plans can offer benefits

Among the many types of life insurance available, permanent life policies are sometimes touted as a way to supplement retirement savings. When you buy a permanent life insurance plan — whether it’s variable, universal or whole life insurance, or a hybrid — some of your premiums go into a separate account that builds cash value alongside or in addition to your death benefit.

One of the advantages of permanent life insurance is the ability to withdraw or borrow against this cash value. You might do this to pay your mortgage for a few months, if you lose your job, or to fund your retirement. Keep in mind that loans and withdrawals will lower your life insurance death benefit unless they are repaid. If you borrow more than the surrender value, your policy could lapse.

On the other hand, there can be tax advantages to getting cash from your life insurance for retirement or other purposes. “Distributions through borrowing are 100% tax free. ... If the cash value is withdrawn from the policy, part is a return of premium and part would be taxed as income,” says John Buerger of ALTUS Wealth Solutions in San Luis Obispo, California.

Tax advantage, but at a cost

There are also tax advantages to using some of your cash value to fund retirement specifically, according to Buerger.

“If a person has $50,000 coming out of their IRA or 401(k) each year along with another $25,000 in Social Security, the whole $75,000 … is considered taxable income. If that $50,000 were coming out of life insurance, then the taxable income would only be $25,000. Not only would the $50,000 not be taxed, it is likely that the person would be in a lower tax bracket meaning the tax on the Social Security income could also be lower,” he says.

But many advisors don’t recommend using life insurance to fund retirement for one big reason: “It’s a very costly way to invest,” says Jeff Vistica, a financial advisor in Carlsbad, California.

“The insurance costs, marketing and commission costs, premium taxes, subaccount costs … quickly add up and will eat away at your returns,” he says. Vistica estimates that these expenses cost about 3% per year.

By contrast, advisors often recommend keeping investment fees at or below 1%.

The high costs associated with life insurance plans create a “drag” on performance, Buerger says. “Typically, we see something closer to 4-6% effective annualized growth rate of life insurance cash value, whereas long-run market performance can be higher,” he adds.

Consider maxing out other vehicles first

This doesn’t mean that no one should consider funding their retirement through life insurance. Vistica suggests that if you’re already maxing out other retirement vehicles — such as 401(k)s and IRAs — and have a life insurance need, you might be a good fit.

But “I’m not a big fan of using life insurance to help fund retirement,” he says. “Life insurance should first be viewed as a way to protect your family or business if something were to happen to you.”

If you’re older and have a high net worth, you’ll reap the most tax savings from life insurance withdrawals, although as Buerger notes, “Tax savings are still tax savings.”

If you don’t need life insurance yet and haven’t reached your peak earnings, you’ll get a better deal with a Roth IRA. And if you’re not contributing the maximum to your 401(k) and IRA, consider working these into your budget before branching into life insurance.

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