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The Surprising Connection Between Life Insurance and Retirement Planning

Can Life Insurance Serve as an Investment Vehicle? 

Yes, some life insurance policies include a cash value component that grows interest over time.  Withdrawals from life insurance are tax-free up to the amount of premiums paid into the policy. Withdrawals above the amount of total premiums (growth of the cash value) would be taxed as ordinary income. 

Almost all permanent life insurance policies include these savings components, though financial protocols and flexibility vary on the type of plan. Some permanent coverage even allows for strategic investing through stocks, bonds, and popular indexes.

What Is Permanent Life Insurance? 

As the name suggests, permanent life insurance provides lifelong coverage. These policies cost notably more than term life insurance, and become more attractive to high earning/high-tax paying individuals due to the tax advantaged growth and desire for permanent death benefit.

While you can cancel a permanent policy anytime and still retain your accrued cash value, doing so can result in “surrender fees.”

Many factors ultimately determine the cost of life insurance, including:

  • Age
  • Gender
  • Tobacco use
  • Overall health
  • Coverage level

For example, because men typically die younger than women, life insurance companies charge more for coverage. Likewise, older customers pay increased premiums due to their higher likelihood of passing away and triggering a lump sum payout.

What Is the Cash Value Component of Permanent Life Insurance? 

While all life insurance coverage centers around the death benefit due to a policyholder’s family, many permanent policies include a cash value component. These plans deposit a portion of your monthly premium into a separate account that accrues tax-deferred interest.  

Policyholders can withdraw these funds for personal reasons, emergencies, or retirement expenses. Members can also borrow against their cash value or use it to pay monthly premiums. While this free access provides many advantages, any distributions from your cash value exceeding the total premiums paid will become subject to income tax. Upon your passing, any outstanding loans against the cash value will be deducted from the death benefit provided to your beneficiaries.

What Is Tax-Advantaged Growth? 

Tax-advantaged growth allows any type of investment, account, or savings plan to grow in interest on a tax-deferred or tax-exempt basis. However, withdrawals that dip into the account growth returns become taxable at their ordinary income rate.  

Though many people utilize conventional tax-advantaged retirement accounts like IRAs and 401(k)s, most permanent life insurance policies offer similar benefits.

How Is Term Life Different Than Permanent Life? 

If you have limited resources and only desire a death benefit to protect your family, term life insurance may better suit your needs. Term coverage differs from permanent life insurance in the following ways:

  • Only covers you for a specified period, typically in increments of 5,10, 20, or 30 years.
  • Does not include a tax-advantaged cash value component.
  • Typically less expensive.
  • All benefits expire at the end of your contract.

Exploring the Types of Permanent Life Insurance 

While the following permanent life insurance policies all provide tax-advantaged investment, each differs in its premium structures and how it grows cash value.

Whole Life Insurance 

Whole life insurance is the most straightforward type of permanent coverage, providing lifelong protection to all members who keep up on their monthly premiums. Unlike universal coverage, whole life insurance premiums never fluctuate from their original rate. Most of these monthly payments go toward your death benefit. The remainder goes toward building your cash value.

Whole life insurance cash value grows at a fixed rate, making it easier for policyholders to understand their overall investment and projected savings. Depending on your contract, your insurer might also pay annual dividends if the company performed better than expected during the previous fiscal year.

Universal Life Insurance 

Unlike whole life insurance, policyholders with universal coverage can increase or decrease their premiums and death benefits as needed. Universal life insurance does not guarantee interest rates, making it a riskier cash value investment. Insurers sell these policies in several sub-varieties, the most common of which include variable universal life (VUL) and indexed universal life (IUL) insurance.

Variable Universal Life 

In addition to freely adjusting premiums and death benefits within policy limits, VUL insurance members can choose how to invest their cash value between various subaccounts. Each of these mimics the structure of family or mutual funds and employs an array of stock, bond, and money market options.

While increased control of their cash value gives members an opportunity for greater investment returns, it also forces them to assume all the risk. In some cases, VUL policyholders can even lose money. If your cash value balance falls below a certain threshold, you may need to pay a higher premium to maintain or salvage your coverage.

Indexed Universal Life 

IUL insurance offers similar coverage flexibility but differs in how cash value accrues interest. Growth centers around the performance of stock indexes, or statistical measurements of specific financial markets, such as the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite.  Members only have to pay capital gains tax on increased cash value if they abandon these plans before they mature.

Unlike VUL plans that put all risk on the policyholder, IUL plans typically set 0-1% investment floors to protect consumers against market losses. However, they can also limit potential returns from overperforming indexes by imposing rate caps on how much they will annually credit to an account.

Our Top Tips for Using Permanent Life Insurance as an Investment 

If you want to utilize permanent life insurance as a retirement investment vehicle, follow these tips to ensure the best possible outcomes:

  • Choose the appropriate investment strategy. Risk-averse individuals should enroll in fixed-interest policies. People who want to maximize their return potential and can tolerate intermittent losses may prefer IUL or VUL plans.
  • Maximize your cash value growth. If you can afford it, pay your premiums at an expedited rate to boost immediate interest gains.
  • Keep up on cash value loans. Any posthumous balance will get deducted from your family’s death benefit. Likewise, your policy may lapse if the loan interest exceeds your cash value.
  • Do not withdraw excessive funds. You can only access the sum of your premium contributions without triggering income tax. Cash value withdrawals that dip into your interest gains will lose tax-advantaged status. 
  • Explore alternatives. People who cannot afford permanent life insurance often secure 401(k) or IRA accounts to collect savings.

In conclusion, life insurance can indeed serve as an investment vehicle, thanks to the cash value component found in many permanent life insurance policies. While this cash value is not classified as a traditional asset by the IRS, it offers tax-advantaged growth opportunities, providing a unique approach to building financial security. 

Plan for your family’s future. Get a life insurance quote today.

Get a quote

Plan for your family’s future. Get a life insurance quote today.

Get a quote