How to use a permanent life insurance policy as part of a retirement plan

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Planning for retirement requires a variety of tools, much like a Swiss Army knife. While many people see whole life insurance solely as a way to provide income for loved ones, it can be a versatile retirement-planning tool.

Tim FitzGerald, the owner of TFG Financial and a top agent with New York Life Insurance Co., cites the flexibility of whole life insurance as an advantage in retirement planning. For instance, while some retirement plans are able to grow on a tax-deferred basis (called qualified retirement plans), whole life insurance makes cash available tax-free. Plus, life insurance provides a tax-free insurance benefit to beneficiaries when the policyholder passes away.

If you’re thinking of using whole life insurance to fund retirement needs, your first step should be to consider how much life insurance you need to support your loved ones. FitzGerald recommends that you answer this question first, then look at using life insurance as a supplemental retirement fund.

Benefits of permanent life insurance as part of your retirement plan

Permanent life insurance can be used as a retirement vehicle once you’ve met the maximum contribution amount your qualified retirement plans.

Victor Sanchez, Assistant Vice President of Strategic Marketing at Transamerica Insurance and Investment Group, cites the portability and flexibility of life insurance as two major reasons for using whole life insurance to help shape a retirement plan. Sanchez says that while 401(k)s, IRAs and other qualified savings plans are important, there are restrictions — such as the 10 percent tax penalty imposed on money withdrawn before age 59 1/2.

One of the benefits of using life insurance as a part of retirement planning is that it allows you to access cash value. Highly rated life insurance companies frequently invest in highly rated bonds. (Check financial strength ratings here.) That means you’re participating in an insurance company’s bond portfolio without the downside risk of the bond market, because most whole life insurance policies give you a guaranteed interest rate and cash value.

What to watch out for

While using whole life insurance to help save for retirement can be beneficial, there are also pitfalls. For example, if you’ll need money during retirement, have your financial planner run an in-force illustration to determine if there will be any adverse tax consequences, says Sanchez.

But the more basic question to start with is: “What is the basis of your contract?” Usually, it is the premium that has been paid, says Sanchez. The other important component is the gain.

For example, take someone who has a contract with $100,000 in basis and $50,000 in gain. If he withdraws $110,000, $100,000 would be tax-free and $10,000 would be taxable.

So for any amount above basis, Sanchez suggests you consider a loan. Loans against your life insurance policy are not taxable, but if they are not paid back they will reduce the death benefit. However, if your beneficiaries no longer rely on you for financial support, your life insurance becomes an additional retirement fund. If you surrender your policy or lapse it before the loan is repaid, the money from that loan becomes taxable.

If you’ve held your life insurance policy for a number of years, a preferred loan at a low interest rate may be available. Another point of caution, Sanchez notes, is not to deduct interest paid on the loan because you risk losing the tax-free nature of the death benefit and the tax-deferred buildup.

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