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How to Use Life Insurance to Pay for Retirement

Most people think of life insurance in terms of the financial benefits it provides after you’re gone but many don’t realize that you may be able to use it to your advantage sooner than that. Certain types of life insurance policies can also be used to generate additional income streams which may come in handy when you’re ready to retire. If you’re interested in supplementing your retirement savings, here’s a look at how permanent insurance products can help to fill the gap.

Which Life Insurance Policy is Right for Me?

Building Cash Value With Whole Life

A term life insurance policy stays in effect for a specific number of years, usually anywhere from 5 to 30 but a whole life policy (a type of permanent life insurance) only expires when you cancel it. Otherwise, whole life insurance covers you for a lifetime. Whole life insurance tends to be more expensive in terms of the premiums but the trade-off is that you’re accumulating cash value in the policy that you can borrow against or withdraw later on. Depending on how the policy is set up, you may be able to reap the added benefit of earning interest or dividends on a tax-deferred basis. (Learn more about different life insurance policies.)

Generally, you can borrow against the policy up to the amount of cash value you’ve accumulated without taking a tax hit. If you’re receiving dividends, you won’t owe any taxes on them unless they exceed the total amount of premiums you’ve paid. As long as you’re careful about much you borrow, you can use a whole life policy as a steady source of income in your golden years. Technically, loans against cash value don’t have to be repaid but you should keep in mind that any death benefit payable to your beneficiaries is reduced by the outstanding loan balance when you die.

Investing With Universal Life

Universal life insurance is also a type of permanent coverage but it works a little differently than a whole life policy. You’re still able to earn cash value based on the amount of interest generated as you pay your premiums but the amount you pay as a premium can be adjusted based on your circumstances. You also have the ability to raise or lower your death benefit as needed and can use the accrued interest to cover the premiums.

For retirees, universal life insurance can be attractive because in addition to building cash value, there’s also an investment component involved. Part of what you pay for premiums goes towards the policy cost and the rest is invested in a vehicle of your choice. Your individual returns are based on how well the investment performs and you can borrow against the cash value tax-free up to the point that withdrawals exceed what you’ve paid in. The only downside to universal life is that returns aren’t always guaranteed so you want to review the prospectus carefully before choosing this type of coverage.

Life Insurance Policy Comparison

Converting Permanent Insurance to an Annuity

If you’ve successfully built up a substantial amount of cash value in a whole life or universal life policy, converting it to an annuity allows you to create a regular source of income. An annuity is a type of contract that you purchase from a life insurance company. Typically, you fund the annuity with a lump sum and the insurer pays you a fixed amount for the duration of the lifetime. A lifetime annuity allows you to receive payments until you die and they may also continue providing reduced benefits to your spouse.

Normally, if you cash out a permanent life policy you’d have to pay taxes on the earnings but you can switch to an annuity tax-free through a 1035 exchange. The death benefit associated with the policy goes away but if you have other assets to leave to your heirs, making the switch can provide some much-needed cash flow for your golden years. When you’re shopping around for an annuity, it’s a good idea to compare the payouts different companies offer to make sure you’re reaping the biggest benefit.

Developing a solid retirement strategy begins with knowing what your different savings and investment options are. If you haven’t thought about how life insurance fits into the picture, you may be overlooking a potentially valuable source of income.

Visit SmartAsset’s life insurance policy comparison page to find a policy that fits your needs.

 

Source: http://www.irs.gov/pub/irs-drop/rr-07-24.pdf 

Photo Credit: flickr

Rebecca Lake Rebecca has been writing about the nuts and bolts of personal finance since 2009. Her work has appeared on a number of popular finance sites, including the Quickbooks/Intuit small business blog and Money Crashers. As a homeschooling mom of two, she's always looking for ways to make the most of every dollar.

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