Should you be Using Cash Value Life Insurance for Retirement?

When it comes to the many options you have to prepare for retirement, the list can sometimes appear a bit intimidating.  You might also notice that among the option, there's very little uniqueness and they all tend to involve much of the same risks and rewards.  While there are variances to the outright risk of losing your money, most retirement savings plans require you to accept some degree of potential losses in exchange for a rate of return better than just keeping the money in your savings account at the bank.

But one option that some people use is life insurance.  Why life insurance?  Mostly because it provides one of…if not the…best protections against losing your money while also providing a rate of return on the money you saved that's far better than what you'll earn on a savings account.

Can you Use a Life Insurance Policy for Retirement?

Yes, you can use a life insurance policy for retirement, and there is more than one way to do it.  The most common approach involves using the policy's cash value as a way to create income in much the same way you'd use your 401(k), IRA, or other retirement planning options.

The second way you might use a life insurance policy for retirement is by allowing the death benefit to ensure you have the funds to either replenish investment accounts for your spouse or to ensure the funds exist for a legacy plan you might have.  Let's dive a bit more into this one as it needs a little more explanation.

Let's assume that you are much older than your spouse.  You know there is a strong likelihood that you will die first, and you want to ensure that your spouse will have the necessary funds to life out the remainder of his/her days without the worry of running out of money.  At the same time, you have to also have access to enough money while in retirement yourself to live comfortably.

Incorporating life insurance into your retirement plan is a way to provide a little more freedom to spend down assets while you are alive.  You can do this because you know that upon your passing, your spouse will receive the death benefit of your life insurance and can use that money to continue to live comfortably in retirement.

Alternatively, let's say that you have a desire to leave money behind as part of your legacy.  This might be money left you an alma mater, a church, non-profit, or maybe your grandchildren.  Whatever your motivation, life insurance could ensure that you have the freedom to spend the money you saved, and have funds left over for your legacy plans through the death benefit of the life insurance policy.

How Cash Value Life Insurance Works in Retirement?

When you buy a pay premiums to a cash value life insurance policy, the policy builds cash value.  You are free to use that cash value in whatever fashion you deem appropriate.  For retirement purposes, this most often takes the form of either withdrawing the money or taking loans against the policy and spending that money on whatever needs you have in retirement.  If you'd like to get an idea of how much money you can accumulate for retirement with life insurance, check out our whole life insurance calculator.

Life insurance even has a few added bonuses that other retirement plans do not.

Life insurance is not subject to early withdrawal penalties.  So if you retire prior to age 59.5, you won't have a 10% penalty tax assessed on any of the money you take from your life insurance policy.

Life Insurance is not subject to Required Minimum Distributions (RMD).  So if you do not retire prior to age 72, there's no requirement that you begin taking money out of the insurance policy or else pay yet another penality tax.

Life insurance does not affect Modified Adjusted Gross Income (MAGI).  This can help you augment your Social Security retirement income benefit.  Using a life insurance policy to cover expenses will not count towards income used to determine how much of your Social Security benefit is taxable.

In certain states, life insurance enjoys numerous liability and creditor protections that make it invisible to those seeking money from you.

Lastly, life insurance distributions are normally tax-free and will remain this way for the remainder of your life provided to follow a few simple rules.

How Do I Use Life Insurance in my Retirement Plan?

You can use life insurance as part of your retirement plan simply by buying a policy.  The life insurance itself will not be part of your other retirement plans.  In other words, it won't be inside your 401(k) or IRA, but instead will be just another asset you own that you can use for retirement.

Once you reach retirement, you can choose to use cash from your life insurance, use cash from your other retirement plans, or use a combination of life insurance and your other assets to cover expenses.

There is nothing you have to officially do to declare your life insurance policy a retirement plan.  It will automatically accumulate cash value for you to use as you wish.

What are the Tax Consequences of Cashing in a Life Insurance Policy?

You should understand that while life insurance provides many tax-favorable benefits, there are consequences to outright cashing in a policy.  Any gain in the policy (i.e. cash value greater than the sum of the premiums you paid) will carry an ordinary income tax liability.  Sometimes, the gain you recognize will not come as cash to you through policy termination if you have a loan outstanding.  This means the tax owed upon canceling the policy could be larger than the amount of cash value you actually receive.

You will also lose whatever death benefit you have on the life insurance policy as well as lose any other benefits you might have had as part of the policy.

2 thoughts on “Should you be Using Cash Value Life Insurance for Retirement?”

  1. Hello Brandon

    Regarding using cash-value life insurance as an income source in retirement. You may want to include the idea mentioned by Brantley several years ago: have all or a portion of the annual dividends paid as cash.

    The dividends will be not be subject to income tax until the sum of the dividends exceeds the policy basis. Of course, we must include the disclaimer that dividends are not guaranteed. Nonetheless, this is a valuable option for obtaining tax-free income from a life insurance policy.

    I refer to this as the “Whitley option” since Brantley is the first and only person I can recall in my experience in the life insurance industry who has mentioned this.

    • I’m not sure that the possibility of dividends exceeding the policy basis is a practical concern. Unless the policy is a limited premium policy, a new premium will be due each year, so if dividends are less that the annual premium the policy’s tax basis will continue to grow. True, if the annual dividend does exceed the premium due, then the total policy basis will begin to go down. But even then the basis will only go down by the amount by which the dividend exceeds the annual premium.


Leave a Comment