For the majority of Americans, retirement planning and life insurance are entirely different things. They nurture the notion which says retirement planning is for your future and life insurance is for the future of your beneficiaries. However, some expert financial advisors recommend life insurance as a perfect way of planning for retirement. Due to the hefty costs involved, the strategy is controversial but if you’re good at it, there are many benefits that you can reap.
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Whole life insurance plans – Best way to support retirement savings
Among the different types of life insurance available, whole life policies are promoted as the best way to support your retirement savings. When you purchase a permanent life insurance plan, irrespective of whether they’re universal, variable, or whole life insurance, a portion of your premiums goes to a separate account which builds cash value along with/in addition to the death benefit of the policy.
One of the core benefits of permanent life insurance is the ability to borrow or withdraw money against the cash value of the policy. You may use the proceeds to pay off your mortgage payments for a few months or to support your family when you lose your job or continue funding your retirement. A point to be noted is that withdrawals and loans will decrease your death benefit unless it’s repaid. On the other hand, there are tax perks on getting cash from your life insurance. As per the IRS, distributions through borrowing are 100% tax-free!
Tax benefits – But with a twist!
There are tax benefits to using a portion of your cash value to finance your retirement. If someone has $40,000 coming from his IRA or 401(k) every year and another $30,000 in Social Security payments, the total $70,000 is deemed as taxable income. However if that $40,000 is coming from life insurance, then the taxable income would only result in $30,000. Not only would that $40,000 be not considered as taxable income, there are even high chances that the person would fall in a lower income tax bracket and the tax on Social Security income could also be lower.
Despite all this good news, most advisors recommend against utilizing life insurance to fund retirement and the key reason is that this is a costly way to invest money. The costs of insurance, commission and marketing costs, subaccount costs, premium taxes will soon add up and will eat away your returns. This high cost related to life insurance plans leads to a drag-on performance.
Consider maxing out other assets first
Though this doesn’t mean that none should consider financing their retirement through life insurance, yet if you have other retirement savings like IRAs and 401(k)s, maxing out those first will be a better option. Wise advisors aren’t big fans of using life insurance to fund retirement. According to them, life insurance should initially be seen as a primary way of protecting your business or family (if something were to happen).
In case you’re older and you have a huge net worth on your life insurance policy, you are eligible to reap the highest tax savings from life insurance withdrawals. Tax savings are innate tax savings. On the other hand, if you don’t require life insurance yet and you don’t think you’ve reached peak earnings, a Roth IRA would be a better deal. If you still don’t contribute the maximum to your IRA and 401(k), make sure you include these into your budget before raiding your life insurance payments.
Hence, if you have been wondering about whether to cash in your life insurance savings for funding your retirement, you should take into account the above-mentioned factors.