As part of your financial plan for your family's future, you may have purchased
Certain permanent life insurance contracts let you build tax-deferred cash value over time. To supplement your income, you may want to consider borrowing this cash value.
Here's what to know about using your life insurance for retirement.
Life insurance contracts that have cash value
These contracts include a cash value component, though each accumulates it differently:
Whole life insurancehas set premium payments and a cash value that is guaranteed to grow. It also has the potential for dividends. Universal life insurancehas flexible premium payments, and your cash value earns interest at a rate that may change over time, never to be less than the guaranteed minimum. Variable universal life insuranceis similar to universal life, except you can choose which market subaccounts you want to invest in, which means you have market-related growth (and loss) potential.
Because universal and variable universal life insurance let you change your premium amount, reducing your payments can affect your death benefit and cash value.
How you can use cash value life insurance in retirement
Your life insurance's cash value is money you can withdraw or borrow. There are no restrictions on how you spend it. You could use it to:
- Supplement your Social Security or retirement distributions.
- Cover unexpected expenses such as medical bills.
- Take a tax-advantaged loan to repay debts or fund a project.
- Pay for extended health care expenses such as assisted living or in-home services.
- Fund your premiums to keep coverage going without out-of-pocket costs.
- Invest in other options that may better help you reach your financial goals.
Withdrawing and borrowing from your life insurance has trade-offs. For one, money taken from your contract's cash value reduces the death benefit. Also, any funds you don't replace aren't included in the death payout to your beneficiaries.
Pros & cons of using life insurance for retirement
Can life insurance be used for retirement savings? Of course. But should you do it? It's an individual decision. Understand the advantages and disadvantages and how using your life insurance cash value works in the context of your overall goals.
Advantages of using life insurance for retirement
- Unlike other retirement accounts, the amount of money you can put into your life insurance each year depends on the size of the contract. It is not capped at a set amount or income based like some retirement accounts (e.g., Roth IRA contribution eligibility.)
- Your cash value's growth is tax-deferred, similar to a 401(k), traditional individual retirement account (IRA) and other non-Roth retirement accounts. But you don't have to wait until age 59½ to withdraw funds from life insurance.
- Some retirement accounts have
required minimum distributions, requiring yearly withdrawals at a certain age. Life insurance contracts don't.
- Life insurance riders may be available that allow you to use your cash value to help cover long-term care costs and chronic or critical illnesses.
Disadvantages of using life insurance for retirement
- Life insurance contracts with cash value features typically have higher premiums than term contracts.
- Investment options within your life insurance contract may offer lower interest rates or returns than other investment possibilities.
- Any cash value you withdraw or borrow and don't repay reduces your death benefit.
How taxes work with cash value life insurance
When it comes to using your life insurance cash value, you can withdraw some of it, take a loan from it or cash it out entirely by
It's vital to understand the tax implications of each. You paid your life insurance premiums with after-tax dollars. But your cash value grows tax-deferred interest and earnings, which means you owe taxes on those when you withdraw them.
Depending on how you take money from your life insurance, these are common tax scenarios you may encounter:
Partial withdrawals of cash value can be taxed as income
You can take out any amount up to the total you've paid in premiums tax-free. For any amount over the premium total—i.e., the interest or earnings—you have to pay regular income tax.
Loans against cash value can be taxed and accrue interest
Like a partial withdrawal, you can take a tax-free loan up to the amount of the premiums you've already paid. Anything borrowed beyond that may be subject to income taxes.
You usually have to pay interest on the borrowed amount. You may need to make regular interest payments or deduct the interest from your remaining cash value. If those interest payments deplete your cash value, however, your contract could lapse, leaving you with full tax responsibilities and no life insurance coverage.
Total withdrawal or surrender
You can also take out all of your cash value and receive the surrender value of your life insurance by ending your contract. While this may give you the windfall you're looking for, you may have to pay surrender fees and income tax on all the interest or earnings at once. You also won't have coverage anymore.
Who should tap life insurance cash value for retirement?
For some people, using life insurance to build or supplement retirement income may align with their goals,
Here are some instances where it could be something to explore:
- If you're a high-net-worth investor, you may have maxed out other tax-advantaged options, like a 401(k) or IRA. A permanent life insurance contract can provide another opportunity for tax-deferred growth and tax-free withdrawals for any amounts under your total premium contribution.
- Withdrawing money before age 59½ usually triggers fees and tax penalties in retirement accounts. Life insurance gives you a way to withdraw or borrow at any age and can be tax-free if it's less than your total premium contribution.
- If you're worried about outliving your retirement savings, using your cash value can be an option to rearrange your savings and investments to set yourself up with additional monthly income.
- Your cash value investment options in life insurance may not be working to their full potential, or they may no longer fit your risk tolerance. You may want to be more conservative and switch to a
certificate of depositor fixed annuity(particularly a multi-year guaranteed annuity) because they can offer set growth over a period of time. On the flip side, you may be looking for something more aggressive, such as dividend-paying stocksthat have market growth (and loss) potential.
More info on how to use life insurance for retirement
When considering life insurance that builds cash value, understand the contract, the fees involved and the potential benefits and drawbacks. Also, consider the primary purpose of
A financial advisor can help you look at your big-picture finances and determine if using life insurance for retirement income aligns with your needs and strategy. Get in touch with a