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September 29, 2017 at 07:40 AM
Permanent life insurance can be a great vehicle for implementing a supplemental retirement strategy, but the details involved with using life insurance that way may be hazy even for financial professionals who have life agent licenses.
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Here’s an introduction to life insurance “life insurance as a retirement strategy,” or LIRS, aimed at financial professionals who are just starting to learn about this topic.
1. What products can serve as good vehicles for LIRS?
The term LIRS captures the more expansive view of permanent life insurance rather than the commonly held notion that life insurance is only useful as a death benefit.
There are many types of life insurance products and LIRS can only be fulfilled with “permanent” life insurance – products that build cash values over time, such as whole life (WL), universal life (UL), variable life (VUL) and indexed universal life insurance (IUL), and generally, will continue death benefit coverage so long as premiums are paid.
Contrast that to “term” life insurance, a policy type that has no cash value or investment component and simply provides a benefit at death. However, term insurance also typically expires after a certain term of years.
LIRS are most stable with WL insurance because of the strength of premium and cash value guarantees, the overall lifetime cost of ownership, and the general predictability and lack of any significant variability that can occur with UL, IUL and VUL. Whole life insurance is intended to maximize both cash values and death benefits, and WL insurance issued by mutual life insurance carriers may also pay dividends that can be used to increase the death benefit and cash values.
2. How do LIRS arrangements work?
LIRS takes advantage of the favorable tax treatment afforded to permanent life insurance by law. The three most important features are (1) income tax-free death benefits; (2) the growth of the cash values inside a permanent policy is deferred from taxation while the funds remain in the policy; and (3) policy cash values can be accessed on a tax-favored basis by withdrawals or through policy loans or a combination of the two.
It is through these last two features that make LIRS stand out as an effective supplement to retirement savings and income. Withdrawals from a life insurance policy are generally treated on a First-In First-Out Basis meaning that withdrawals to the extent of cost basis are considered a tax-free return of cost basis. During the insured’s life, loans taken against a whole life policy will generally not trigger a taxable event, even though the policy may have a large gain in excess of premiums paid. Cash values can be accessed on a demand basis through a policy loan at any time and for any reason, without the application and approval process that is required for consumer or business loans. Once a policy loan has been taken, any annual dividend paid can be used to help pay back a policy loan. If the loan is not repaid, the loan balance will merely reduce the death benefit and cash values.
3. Who are LIRS ideal for, and who should stay away?
LIRS is ideal for anyone seeking to maximize cash values for retirement beyond employer sponsored retirement plans and IRAs. They must also have a need and/or a desire for life insurance coverage because after all, these are life insurance policies first and foremost, and the premiums paid are partly directed towards the death benefit protection of the insurance.
(Photo: Thinkstock)
Practically every adult has some desire or need for life insurance, but those who have limited financial means and cannot even take advantage of matching programs from an employer sponsored retirement plan should probably seek to maximize that benefit first.
