By now, anyone who isn’t on good terms with a rich uncle knows the importance of saving for retirement. And as we’ve been told countless times by parents, teachings, and the experts on TV that means having a 401(k) through your job, a well-funded IRA, and whatever we may be able to count on from Social Security. For some lucky people, it may even mean all three.
But there’s also another surprising financial option that doesn’t get as much attention or consideration. And it should. Life insurance.
Life insurance? Retirement plan? They’re two separate things, aren’t they? Well, there are several important reasons for people to include both in their long-term retirement plans. Certain types of life insurance can help you protect what you’ve already saved, while others can help you save more tax-deferred. Your strategy will, of course, depend on your current assets, income, and retirement goals.
Start simple. Protect what you’ve got with term life insurance.
As the most popular form of life insurance available, term life offers two principle benefits when it comes to retirement.
To begin with, term life offers a guaranteed death benefit. In the event of unexpected and untimely death, it offers financial security during the years you’re raising your family while you’re also saving for retirement. That means your family won’t have to raid your retirement assets to get by. It also means that depending on how far off retirement is, your spouse can potentially continue to save for it. Protection for your family today, and tomorrow.
The second benefit of term life is its low cost. Because you can protect your family’s finances with a small amount out of pocket each month, you have enough left over to fund your 401(k) or IRA. It may even leave you with enough money to create an emergency fund, and protect against other surprise expenses. See how much term life may cost you.
Set aside cash for an emergency fund.
Experts recommend that every family have an emergency fund to cover between three and six months’ worth of expenses. Having this extra money on hand can help keep you from using credit cards should you get hit with a surprise expense, or your income dips. Because avoiding credit card debt – and the heavy interest burden that goes along with them – is one of the best ways to stay on track with your retirement savings.
Step up retirement savings with permanent life insurance.
While term life offers lower premiums and the ability to protect your family for a specified period, permanent life offers two important reasons to consider it as part of a retirement savings plan. One, of course, is that permanent coverage never expires. As long as the policy remains in force, you’re covered. But even more important is that over time, permanent life insurance builds cash value.
Of course, using permanent life insurance to build assets isn’t for everyone, and experts will tell you to max out other vehicles like an IRA and 401(k) first. But if you’ve done that and still have assets to invest, permanent life insurance is an opportunity to set aside significant tax-deferred assets for retirement. Let’s see how it works:
When you buy a permanent life insurance policy – whether whole life, universal, variable, or a hybrid, some of your premiums go to cover the policy and some goes to a separate account that grows alongside your death benefit. But what makes this strategy most interesting for anyone who’s already contributing the maximum to their retirement accounts – there’s no contribution limit when using a life insurance policy for retirement planning.
Think about it. For those under age 50, the maximum 401(k) contribution for 2017 is $18,000 and just $5,500 for a traditional IRA. By adding a permanent life insurance policy to your retirement plan, you increase the amount you can set aside – and grow tax-deferred – to any amount you like. What’s more, unlike a 401(k) or an IRA, there usually are no limits as to how much you can withdraw or when you can withdraw it.
And, your heirs will thank you too. Your beneficiary pays no taxes on the death benefit from a permanent life insurance policy. But a traditional IRA or 401(k)? If you’re not careful, your beneficiary could get hit with a huge tax bill.
While those are the broad outlines of using permanent life insurance in retirement planning, there are key differences in this strategy between whole life and universal life. Let’s see what using life insurance for retirement planning could mean.
Whole life offers less risk. It’s fair to ask, is whole life a good investment for retirement? Whole life is designed to protect you for your entire life, so it’s much more expensive than term life. But the trade-off is that the policy builds tax-deferred cash value. It’s also a highly conservative option, earning a lower return in interest and dividends by putting the money in more stable investments.
Universal life means greater flexibility. Another important type of permanent coverage is Universal Life. While a portion of your premiums are still allocated between the policy and a separate cash account, you can select where the money is invested. Now, while you’re assuming the same downside risks as you would if you invested directly, this flexibility does offer the potential to accrue significant tax-deferred returns. And once you retire, you can borrow against the cash value, generating additional income.
Consider converting to an annuity. Once your whole or universal life policy has accumulated a significant cash value, you can consider converting the policy into an annuity, tax-free. Annuities are contracts with an insurance company. In return for funding the annuity with a large lump sum – in this case the proceeds from your life insurance policy – the company pays you a fixed amount every year for the duration of the contract. With a lifetime annuity, those payments continue until you die, and depending on the terms of the annuity, can continue paying benefits paid to your spouse after your death.
Once you convert a life insurance policy into an annuity, you will lose the death benefit, of course. But the annuity can offer a retirement income for the rest of your life. And, naturally, not all annuities are the same. Be sure to compare payouts from different companies, so you find one with the most generous benefits.
So, while it’s a great idea to have a retirement savings strategy in place, it’s also important to make sure you’ve explored every possible option. For many people – across a wide range of financial circumstances – using life insurance to fund retirement may provide an extra boost to ensure your long-term success.