Life insurance can offer more than a death benefit

By Carma McCallie

Life insurance can address a multitude of life concerns. The death benefit is especially helpful in providing a replacement for lost income to the insured’s family, covering estate settlement costs, including estate taxes or providing liquidity for business buyouts. But specific policies offer more than just the death benefit. Permanent policies can provide for an accumulation of cash value, and that cash can often be used for the insured’s lifetime needs, including supplemental retirement income.

How does it work?

When we look at saving for future goals and needs, there are generally three income buckets of wealth to consider: taxable, tax-deferred and tax-free. Each has advantages and disadvantages but, overall, taxes can significantly impact the amount of income available in the first two buckets. And since no one knows precisely what tax rates will be 15 or 20 years in the future, it is often difficult to estimate how much income will be available from those buckets in retirement.

How can life insurance help?

For those interested in the death benefits life insurance provides, permanent policies can have unique characteristics and tax advantages that make them a smart addition to an overall retirement savings strategy.

Policies can be structured for cash value growth over time.
The cash value in a life insurance policy grows tax deferred.
Withdrawals from a policy are made basis first, so no tax is due when withdrawn.
Loans on the policy are also not subject to tax at the time of receipt.
The income stream is not locked in — it can be stopped any year the owner doesn’t need it.

So using the cash value of a life insurance policy for supplemental income can result in an attractive tax-free income stream to supplement other income sources for lifestyle needs. But does this idea still make sense, given today’s markets? Absolutely! Like any retirement plan, the assets need time to grow. With life insurance, ideally, we are looking for at least a 15- to 20-year time horizon; typically, the longer, the better. During that time, as the cash value grows, a key benefit can be that it might receive creditor protection under state law. In addition, should the owner die during that period, life insurance is a self-completing plan — the death benefit pays out to the beneficiaries income tax-free.

But what if the owner lives to retirement? Does the life insurance still make sense?

Assuming the owner has the choice between taxable or tax-free income, a distribution of $150,000 from the taxable bucket, assuming a 40% tax, would net $90,000 after taxes. However, the full amount of the $150,000 withdrawal from the tax-free bucket would be available. That’s an additional $60,000 per year in spendable income in retirement!

And let’s not forget recent changes to the federal regulations to Internal Revenue Code Section 7702 regarding how much premium in relation to death benefit can be paid into policies without adverse tax effects. Now owners can put more money into the policy in the early years to allow for future growth. These changes as well the tax and product benefits mentioned previously have even the most ardent critics of life insurance taking a second look at this approach as part of their portfolio.

Is this idea for everyone?

Probably not. Life insurance works best for people who have a need for the death benefit in addition to income in retirement. For example, for those concerned about income replacement during their working years, life insurance death benefits can address that need. If the policy accumulates cash value, it might be able to cover two needs — income replacement while working and an income stream in retirement. It also isn’t for people who might need the money in the next few years; as discussed previously, life insurance cash values need time to grow. And finally, life insurance should not be a substitute for other retirement savings options such as qualified plans and individual retirement accounts.

Now more than ever, the versatility of life insurance can provide so many options, both for living and death benefits. New products and recent changes in tax law make life insurance a viable choice for anyone looking for income protection now, along with tax-efficient income streams in the future. And while it doesn’t replace more traditional retirement planning accounts, layering on the additional tax diversity of tax-free withdrawals might help mitigate the impact of taxes, leaving more income available to help create a robust and healthy retirement!

Carma McCallie, JD, is vice president, advanced markets, with Crump Life Insurance Services. She may be contacted at carma.mccallie@innfeedback.com.