Life insurance, first and foremost, is about protecting loved ones after you’re gone. But some insurance types can actually help you in retirement as well.
Most people think of life insurance in terms of the payout it provides beneficiaries after the policyholder dies. But did you know that certain life insurance policies can financially assist you through your lifetime and into your golden years?
Why Life Insurance is Vital
Life insurance plays a significant role in protecting you and your family during your primary income-earning years. Ultimately, striking the right balance between investing for your future so you can retire when and how you want to, and purchasing the right amount of life insurance to protect your interests today is ideal.
What's more, insurance transfers the financial risk of life's events to an insurance company, and a sound insurance strategy can help protect your family from the financial consequences of those events. A strategy can include personal insurance, liability insurance, and life insurance.
The Retirement Planning Connection
For many of us, life insurance is something to worry about “later.” Or, if provided by an employer, just another part of the employee benefits package. But life insurance can and should be an important aspect of retirement planning.
During retirement, it is well advised to financially prepare for unexpected expenses. Did you know that medical bills are the leading cause of bankruptcy in America? This disturbing fact is that over half of those who are forced to file for bankruptcy have health insurance. Without an emergency cash fund, where will you come up with the money to pay the doctor if your health insurance is denied?
You may be able to cover income shortfalls by using your life insurance for retirement income.
Using Life Insurance for Retirement Income
First things first, you need to understand the different types of life insurance and how they can assist your cash flow in retirement. Unlike 'term' life insurance, which covers only a set number of years, 'permanent' life insurance is meant to be for life. Permanent life insurance can provide a source of supplemental retirement income, which include whole life, universal, and variable life insurance policies. Here's a breakdown of the differences you should be aware of:
- Term insurance is the least expensive, so you can afford to purchase higher amounts of coverage. You can layer term life insurance on top of permanent life insurance to have protection during those high-need years when the loss of your income would be the most devastating to your family. It pays “if you die” during the set term period.
- Permanent (or cash value) life insurance is an important foundation to establish protection over your lifetime. It pays “when you die.” The two primary types of permanent life insurance are whole life and universal life.
- Whole Life Insurance offers consistency, with fixed premiums and guaranteed cash value accumulation.
- Universal life insurance gives consumers flexibility in the premium payments, death benefits, and the savings element of their policies.
Determine a Retirement Plan That’s Right for You
Before deciding on an insurance plan, you should decide what you want your golden years to look like. Some key questions to consider include:
- Do I have enough coverage now?
- Is it the right type of coverage?
- How much coverage will I need later?
- What are expectations for the financial markets in the short and long term?
- Which type of insurance will best meet my future needs?
- How can insurance be integrated with other retirement assets?
- Should I buy a term or permanent policy?
- If I choose permanent, what type?
- Which provider should I choose?
Since choosing a life insurance policy with a cash value component requires a bigger investment, it’s important to understand how this aspect of your policy works and what your options are for using it.
What Can I Do With the Cash in a Permanent/Cash Value Plan?
Permanent/Cash Value policies provide a living benefit, or a perk of your policy that you can use while you are in fact alive and well. Here’s a look at the ways you can use your life insurance to accumulate cash value:
- Withdraw Cash: The cash value component serves as a living benefit for policyholders from which they may draw funds. But make sure to review how your policy works before you do so. Generally, withdrawing your cash value will reduce your death benefit, therefore a more tax-effective option is to withdraw only what you need each year.
- Pay Premiums: These life insurance policies are often favored because they allow you to use the policy’s cash value to pay premiums. This strategy will only work for a short period of time if you start while the cash value is too small or if interest rates are low. Be sure to carefully monitor the cash value to make sure it doesn’t drop too far, or you may lose your coverage.
- Exchange it for an Annuity: The IRS lets you swap your permanent life insurance for an annuity through a 1035 exchange, which is a tax-free transfer of one contract for another. This move can generate more retirement income.
- Convert to a New Policy to Pay for Long-Term Care: If you’d like coverage for long-term care, consider converting your life insurance into another policy with a long-term care rider. You keep your life insurance, but part of the death benefit can be used to pay for long-term care expenses.
- Use it as Collateral: The cash value is an asset that increases your chances of qualifying for a loan or mortgage from a lender. It can even serve as the loan’s collateral. Always ask your insurance expert before using cash value this way.
- Let it Grow: Left alone, the cash value will continue to accumulate, leaving a larger inheritance for your heirs, as withdrawals and loans reduce the final death benefit.
Income Tax Advantages
While its primary function is to help protect loved ones in the event of your passing, life insurance, in particular whole life insurance, can also help you and your beneficiaries manage tax consequences. The following three advantages apply to whole life insurance and other permanent insurance policies:
1. The death benefit is generally paid out income tax free: Life insurance policy payouts can be pretty hefty and avoiding a major tax bite can be consequential.
2. The total cash value accumulates on a tax-deferred basis: Whole life insurance builds up cash value over time as you pay premiums. This is money that grows without the IRS dipping their hands in.
3. You can access the cash value of the policy on a tax-advantaged basis: Money borrowed or taken from the cash value of a life insurance policy is not subject to taxes up to the “cost basis” – the amount paid into the policy through premiums.
Generating income during retirement is challenging. Fortunately, your life insurance policy can be a valuable source of funds to cover retirement expenses by offering tax-free income, (be part of a tax management strategy), and enhance the overall returns from an investment portfolio.
And don’t forget that life insurance only gets more expensive the longer you wait, so starting as soon as possible will only help you in the long run. For more information on how you can best utilize your life insurance policy in retirement, contact the trusted financial advisors at Agemy Financial here today.