- 6-Minute Article
- Jan 30, 2017
The Role Life Insurance Can Play in Your Plans for Retirement
Discover how permanent life insurance policies can help cover large expenses and provide tax advantages.
Updated: March 3, 2023
- What are some key differences between term life insurance and permanent life insurance?
- What are the benefits of a permanent life insurance policy?
- What is a rider and what additional features can this option provide?
Most people understand the importance of purchasing life insurance to provide protection that can help offset enconomic loss for their loved ones.
With term life insurance, one can purchase this protection for a specified period of time with premiums remaining the same during the period, and money is paid to the beneficiaries if the insured person dies during that specified period or term. In contrast, permanent life insurance provides protection throughout the insured person’s entire life as long as the policy owner continues paying premiums and will pay the death benefit whenever the insured person dies.
Permanent life insurance also goes beyond basic protection by providing the opportunity to build cash value through interest credits, market returns, or dividends. That cash value can be used in the future for your children’s education, emergencies, retirement needs, or any other purpose, typically without triggering income tax on a policy loan.
The primary purpose of permanent life insurance is providing beneficiaries with a death benefit. It’s not a savings, investment vehicle, or retirement plan, but if needed, it can provide flexibility and access to a policy’s cash value, making it a valuable addition to your plans for retirement.
A closer look at permanent life insurance
Premiums for permanent life policies can be higher than term life policies because the coverage is provided for life and there is potential to build cash value that can be used in the future.1 Permanent life insurance policies offer several other benefits as well, including:
- Generally no penalty for withdrawals taken before age 59½, providing flexibility for meeting cash needs at any age2
- No required minimum distributions (RMDs) requiring withdrawals at a certain age, such as at age 73, allowing assets to continue growing for longer periods and providing a potential pool of money for later in retirement
- The potential to transfer wealth to beneficiaries through a generally tax-free death benefit3
3 uses for future retirement needs
A diversified plan for retirement typically includes a range of savings and investment vehicles, such as 401(k)s, IRAs, and assets like stocks and bonds held in brokerage accounts. Adding permanent life insurance can complement this mix by providing a death benefit to help cover expenses for beneficiaries if anything happens to the insured person along with access to tax-advantaged cash value.
Here are three potential uses for permanent life insurance to consider for your plans for retirement:
1. Providing a source of funds to help cover large expenses
Permanent policies typically grow their cash value relatively slowly during the first years of a policy, as most premiums are being used to fund the death benefit.4 That means a permanent life policy isn’t likely to be a large source of funds early in retirement. After the first 10 years or so, policyholders can tap the cash value of permanent life insurance if needed through:
- Withdrawals. Policyholders can withdraw from the cash value for any reason, and withdrawals may be especially helpful in managing large expenses during retirement, such as medical costs or home repairs. The money taken out may be tax-free as long as it is a return of the policy’s cost “basis” (generally premiums paid less prior withdrawals). Policyholders can withdraw some or all of their cash value, however, keep in mind this could significantly impact the death benefit.5 If the withdrawals exceed the amount paid in premiums and include some gains, the portion of the withdrawal made up of those gains will be taxed at the policyholder’s ordinary income tax rate. However, withdrawals will permanently reduce the policy’s cash value and future death benefit. Depending on the policy, there may be fees for making withdrawals and some policies only allow withdrawal of all of the policy cash value. It is important to review the policy’s provisions and consult with your tax professional.
- Loans. Policyholders can take loans from their cash value. While often not taxable, loans typically have a set interest rate and will permanently reduce the policy’s cash value and death benefit if not paid back.6
It’s important to remember that the key difference between permanent life insurance and other portfolio assets is the generally tax-free death benefit it provides. Withdrawing too much of a policy’s cash value during retirement can reduce the amount of money available for beneficiaries as a death benefit, potentially eliminating the primary purpose of a permanent life insurance policy. Policyholders should examine any near-term uses for their plan’s cash value against the potential impact on their future death benefit, seeking a balance between meeting current needs and maintaining protection for loved ones. A financial professional can help find this balance. Consult a tax professional to determine any tax consequences.
2. Opportunity for tax-deferred cash value accumulation
The cash value in a permanent life policy can grow tax-deferred, meaning the policyholder won’t owe taxes on gains until they begin withdrawing money. With this feature, policies can serve as a complement to other tax-deferred savings options, such as IRAs and workplace retirement plans. A permanent life policy may be especially attractive to people who max out their contributions in workplace plans and traditional IRAs and are not eligible to contribute to Roth IRAs.
3. Helping to cover health care costs with optional riders
Some insurance companies offer optional features (called riders) that can be added to life insurance policies to help protect against health care costs that may not be covered by Medicare or other insurance in retirement. These riders either give policyholders early access to their death benefit (which permanently reduces the value of that benefit) or cover the care outright.7
For example, a chronic illness rider can help pay for expenses that arise from being permanently incapacitated by a chronic illness, such as Alzheimer’s. With a chronic illness rider, a portion of the policy’s death benefit is accelerated, and funds can be disbursed in advance to pay for any need, including non-medical expenses.
For people who are eligible, selecting one of these riders may help prevent other retirement savings from being consumed by health care costs. Insured individuals must qualify to receive the accelerated death benefits by a licensed health practitioner. A financial professional can help determine if it makes sense to add a rider to a life insurance policy at the time of purchase.
|* Each category includes guaranteed death benefit||Growth/Risk Profile||Method of Growth|
|Whole Life||Lowest growth potential and limited access to cash value in early years but more guarantees.||Provides guaranteed cash value with a calculated rate of return. Additional growth potential provided through dividends, which are not guaranteed.|
|Universal Life||Steady growth potential and access to cash value in early years but with fewer guarantees. Also offers flexible premiums and allows policyholders to cover premiums from accumulated cash value.||Minimum interest rate with opportunity for additional earnings if the insurance company’s current declared rate of interest exceeds the minimum rate specified in the policy.|
|Indexed Universal Life||Higher growth potential and access to cash value in early years but with more potential volatility than universal life.||Interest rates based on performance of a market index (such as S&P 500®); policy funds are not directly invested in the market.|
|Variable Life||Highest growth potential and access to cash value in early years but with greatest exposure to potential volatility.||A portion of premiums are allocated to subaccounts directly invested in the market; cash value can rise or decline based on performance of those subaccounts.|
While protection is the core purpose of all life insurance, permanent life insurance can offer distinct tax advantages, growth potential, and access to cash that may help strengthen an overall plan for retirement. A financial professional can help determine the right type of life insurance policy to consider adding to your plans.