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Income for Life Retirement Strategy #9: Invest in Permanent Life Insurance

The majority of us purchase life insurance policies to provide financial security for those we love after we are gone. However, buying a permanent life insurance plan could offer another valuable source of income for life heading into retirement.

Permanent life insurance plans include two elements. First is the death benefit — which is the amount that will be paid to your beneficiaries when you die. The second is the cash value — a tax-advantaged savings account that is financed by some of your premiums.

Whole life or universal life policies are where companies promise interest is added to your account every year. It is typically a minimal amount that you are paid after insurance costs and expenses are deducted. There are also variable life insurance policies where you choose the investments, but usually without a guarantee.

Since the cash value portion of permanent policies is tax-advantaged, you can withdraw your basis—or the sum of the account that you have paid in premiums—and you can do so tax-free. That amount is essentially a cushion in the event you need it. However, you want to take note that withdrawals in excess of the amount in cash-value accounts will be taxed and are done so on your top tax bracket.When you utilize the policy this way, the death benefit is reduced by the amount you withdraw each time.

Another benefit is that your ability to borrow from the policy without having your credit checked. Interest rates vary anywhere from 5-8%. Rates are based on market prices and depend on whether the loan is variable or fixed. You can either repay the loan or allow the death benefit to be reduced by that amount if you die.

This loan differs from that of a 401(k) policy in that you are not required to pay it back. Instead, the insurance company loans you the money with your policy serving as collateral. However, if you don’t pay the interest it is added to the balance. Another caveat to this is, if the balance exceeds the policy’s cash value, the policy may lapse, meaning you will owe taxes on the loan and cash value in excess of any premiums you paid.

Income for Life series

If these first scenarios don’t work for you and you need to create a consistent source of income, then you may want to consider converting your policy into an annuity. You can do so through what is called a 1035 exchange. The disadvantage of this approach is you are giving up your death benefit. However, you are guaranteeing yourself an income for life or at least so many years. The conversion is tax-free, however, you are required to pay taxes a portion of the payouts you receive. That amount will depend on the proportion of your basis to your gains. While you may start with your insurance carrier, it is also wise to check on the payouts from income annuities with other providers as well.

Another variant to keep in mind when utilizing insurance is if you happen to own a policy that pays dividends then you may be able to generate income without sacrificing the death benefit. So instead of reinvesting your dividends in the policy to increase your death benefit or cash value, you can opt to receive cash instead. Typically dividends vary from 5 – 6.7%. Additionally, dividends are tax-free up to the cost-basis of the policy. Anything beyond that amount and you will be taxed.

Life insurance can serve as just another strategy to make sure your nest egg outlives you. However, it is often extremely complicated and should not be tackled alone. Speak with your CERTIFIED FINANCIAL PLANNER™ before doing anything. If you don’t have one and need help contact me.


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