Will Your Life Insurance Policy Be a Blessing or a Curse in Retirement?
By Alan Olsen
There are several ways to save for retirement. The most obvious path is to start an individual retirement account (IRA) or 401(k) and begin saving money every time you earn a paycheck. However, there are other effective ways to save for retirement. Many people invest in the stock market, or other assets, and others use their life insurance policies.
Insurance for Life
That’s right. There are certain types of insurance policies that can pay dividends in retirement. However, you have to be careful, because they could also hurt you. It starts with a whole life, or permanent, insurance policy. Term life policies are different in that they only last for a preset amount of time. When the term runs out so does the policy. Permanent life insurance lasts as long as you do, so long as you keep paying the premiums. Additionally, the death benefit is usually paid tax-free.
There is another benefit to permanent life insurance policies. They also include a cash value savings account. These accounts can grow in several ways, depending on the policy you choose: whole life, universal life, or variable life. Each has its own pros and cons. But all can be used to help save you on taxes and give you a nice cash cushion in your golden years. You can do this in the form of a loan.
Using Your Policy for a Loan
There are plenty of reasons to borrow from your permanent life insurance policy and use it as an emergency fund. Let’s say you want to use some of the cash from your policy. You can take as much of the fund that you originally invested tax-free. However, if you take out any earnings from the policy it will likely be subject to taxes. On the other hand, borrowing from your policy in the form of a loan is also tax-free. When doing this, you use the policy as collateral and you get take a tax-free loan from the cash value.
Tax-Free Emergency Fund
This method probably shouldn’t be used as a primary investment strategy, but it is a great way to setup an emergency fund for something unexpected. Additionally, the repayment interest rate is generally low, especially when compared with the 10 percent plus interest rate you will likely find on a three-year personal loan. And using a credit card, which usually comes with a 17 percent interest rate or higher, is even worse. So using your life insurance policy as a way to borrow money can be very beneficial in retirement. Especially when something unexpected occurs.
There are some potential pitfalls to this strategy. Borrowing from our insurance policy can be a problem if you do it too often without paying back the loans. So be cautious not to borrow more than you can afford to pay back. Likewise, if you end up in this situation and you can’t pay your premiums, your policy will lapse and you will be stuck with a tax bill. The safest way to use a permanent life insurance policy is to make it one part of your overall retirement plan, and not the main source.