BEST Life Insurance as Retirement Plan
BEST Life Insurance as Retirement Plan
While the primary role of life insurance is to offer financial assistance to your loved ones after you’ve gone, it may also offer the potential for “tax-free” retirement income.
In fact, certain types of life insurance offer you the opportunity to build up cash value within the policy that you can access through policy loans and withdrawals—and take advantage of tax benefits in the process.
Tax Advantages of Life Insurance as Retirement Plan
When considering retirement, many people think of IRAs and 401(k)s.
Contributions to these retirement plans are made with pre-tax dollars, saving you taxable income in the years contributions were made.
However, they do come with some drawbacks when it comes to taxes: in traditional IRAs and 401(k)s, once you’re eligible to withdraw your savings at age 59 ½, you must pay income taxes on the full amount you’ve saved as you receive payment, and you may be concerned about how tax rates could change in the future and what you might eventually owe in taxes.
Life insurance works differently. Premiums paid into a life insurance policy are made with post-tax dollars.
While that doesn’t help reduce your taxable income up front, you won’t owe taxes on the amount of money you’ve paid into your life insurance policy or on the death benefit that gets paid out.
By paying taxes now at historically low rates, unknown future tax rates won’t affect the amount of money paid to you or your loved ones.
Life insurance has amazing tax benefits for you in retirement, including the fact that it does not have a required minimum distribution amount, which makes it superior to 401ks and IRAs in this regard.
- 401k plans and IRA plans require (i.e. you have no choice) you to take out required minimum distributions (RMDs), which are taxed as ordinary income, i.e. based on your income tax bracket.
- The result is that your social security benefits may be taxed and Medicare part B premium penalties may apply.
Top Differences between Life Insurance Retirement Plan VS 401K Plan
Those that are promoting cash value life insurance will sometimes try to market it as a retirement plan by comparing it to 401k plans.
However, a 401k plan is a scam designed to take your more valuable dollars and give less valuable dollars back to you down the road.
Those that are critical of life insurance, typically financial advisors who are pushing 401ks or mutual funds, will be quick to say that a life insurance retirement plan isn’t really a “plan” in the same sense as a 401k is a plan.
Well, that’s true to some degree, it’s just a section of the tax code.
However, it would seem that if someone says that they have a “plan” for using their cash value life insurance to save for the future…well, that would probably be be a plan.
And, I don’t know how you can say that isn’t a “plan.” A 401k is also just a section of the tax code, and yet most consider it a “plan.”
But to be more specific, there are some key differences between the Life Insurance retirement plan and the 401k “plans.”
When examining the 7702 plan (Life Insurance Retirement plan) pros and cons vs the 401k, one major pro is that life insurance is a contract between the company and the policy holder.
There isn’t a third party involved, i.e. no middle man.
Another 7702 plan pro is the tax advantages.
The money you pay into your policy grows tax-deferred and experiences true compound growth.
Further, the cash value in your policy can be accessed tax free through life insurance policy loans.
Additionally, if you use whole life insurance to fund your 7702 retirement plan, you are using a non correlated asset.
Saying whole life insurance is a non correlated asset is simply saying that whole life insurance is not tied to the stock market.
And that is a good thing since it allows diversification and avoids potential stock market crashes that could be looming in the not so distant future.
And finally, unlike a 401k or IRA, your life insurance policy also has a death benefit that is paid to your beneficiary tax free.
And be aware of one con of a 401k plan is that it requires a custodian, or middle man, to handle your funds on your behalf.
Another con of a 401k plan vs 7702 plan is the 401k has no death benefit and therefore there is no additional money going to your beneficiary when you die.
Finally, the 401k proceeds paid to your beneficiary will most likely be taxed.
In contrast, under a 7702 Life Insurance retirement plan, the proceeds paid to your beneficiary are not taxed against your estate or against your beneficiary as income.
In these ways the two “plans” are different. But for those that want to create a “plan” for some sort of long term savings vehicle, you can use the term “plan” to describe both cash value life insurance and 401k.
401K are not tax deductible
401(k). They certainly aren’t tax deductible, but rather tax deferred vehicles.
That is unless you’re talking about the company’s contribution.
This gets into more complicated tax questions because there are approaches to create tax advantages for businesses paying into life insurance plans such as split dollar plans, etc.
However, the more general answer is that life insurance is not generally tax deductible to whomever is paying into the policy so.
However, unlike CD’s and other financial accounts, the gains aren’t taxed in the year earned but rather deferred as long as they are left in the policy…in this way, cash value life insurance may be considered similar to a 401(k) but with more flexibility.
When thinking about 401(k) contributions, the question becomes whether you think it makes sense for someone to pay taxes under today’s rates vs. tomorrows, and other questions emerge like tax bracket considerations.
Certainly, a 401(k) may be beneficial if there is a company match, and yet there is also the looming market risk.
How to convert Life Insurance to Income for Life
If your needs change significantly after you first purchase a life insurance policy, or there are newer policies available that offer benefits or riders not previously available, then it may make sense to exchange your policy for another. Most life insurance policies offer the flexibility to do that—without worrying about taxes.
What’s more, if at some point you no longer have a need for the original death benefit but want income in retirement, you have the option to convert your policy’s cash value to an annuity. This makes it easier to receive guaranteed income for the rest of your life (depending on the type of annuity). Since life insurance is paid in a lump sum after you die, some people choose to move their money to an annuity to provide guaranteed retirement income only annuities provide.
By using a 1035 exchange, the transfer is completely tax-free. The life insurance death benefit is eliminated, but, instead, you receive steady income from the annuity without paying income taxes on your principal, because these funds have already been taxed. If you don’t have any beneficiaries and don’t want to leave money behind, exchanging your life insurance for an annuity is one way to use these funds to your advantage while you’re alive.
If you’re considering a policy exchange, make sure you evaluate your current and future needs, and any consequences there may be to your overall retirement strategy as a result—such as a surrender charge on the old policy, new surrender charge period on the new policy, and other considerations and differences between the old and the proposed new policy.
USING LIFE INSURANCE TO SUPPLEMENT RETIREMENT INCOME
The concept of using life insurance to supplement retirement might seem foreign, but permanent life insurance cash value accounts can offer a variety of advantages in retirement.
Under current tax codes life insurance cash values grow tax deferred and policy loans are tax free and do not have to be repaid as long as the policy remains in force until the insured’s death.
A properly structured life insurance policy provides a tax-free death benefit as well as a tax advantaged retirement income stream, and should be considered in an overall holistic financial plan.
Contributing to a Roth IRA/401k and maximum funded permanent life insurance are ways to hedge against higher tax rates in the future because the distribution from these types of accounts are generally tax-free.
One advantage of permanent life insurance over Roth accounts has to do with contribution limits. In a life insurance contract the maximum death benefit an insured can qualify determines how much they can contribute to the policy.
For example, a 40-year-old male who makes $100,000 per year can usually qualify for a death benefit in the amount of twenty-five times their income ($2,500,000).
This death benefit allows a contribution in the ballpark of $100,000 without losing it tax advantages, whereas contributions to Roth accounts are much lower.
Furthermore, incomes restrictions eliminate some high-income earners from contributing to Roth accounts which makes permanent life insurance a viable option. Another advantage of life insurance over Roth accounts is the ability to access the account value before age 59 ½ without incurring a premature withdrawal penalty.
Permanent life insurance can be one of the most versatile retirement tools available because the owner controls the contribution and distribution of the account value.
Financial Benefits of Permanent Life Insurance in Retirement Plan
As you can see, permanent life insurance policies provide a plethora of financial benefits.
Structured correctly, these policies allow you to build wealth, transfer wealth to your heirs and provide a tax-free financial cushion for your family.
So while taxes are still an inevitability, a life insurance policy can help reduce or eliminate the amount your family might have to pay the taxman in the end.
Mintco Financial Retirement Planning Advisors
When it comes to planning for your protection and retirement income needs, life insurance may be a good option for you.
But, as with all financial strategies, it depends on your specific needs.
A financial professional can help you develop a strategy that works for you and your retirement goals.
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