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Life insurance can provide your family with a cash windfall if you pass away while your policy is active. That could replace your income and prevent a financial catastrophe for your loved ones. Some life insurance policies also accumulate a cash value that you can draw on as needed. This money could be an extra source of retirement income, but there are pros and cons to consider.
Can You Use Life Insurance to Fund Retirement?
There are two main types of life insurance:
- Term life insurance: With term life insurance, your policy will last for a predetermined amount of time, often 10 to 30 years. You can choose your term length and coverage limit. Your premiums may be based on your health, age, gender and risk factors. Term life insurance policies do not accumulate a cash value.
- Whole life insurance: This usually provides lifelong coverage—and a portion of your premiums go toward an interest-bearing account that grows on a tax-deferred basis. You can borrow against your policy's cash value at any time, including in retirement.
The cash value in your life insurance policy can provide a tax-free source of retirement income. You can access it through direct withdrawals, which will reduce your death benefit, or by taking out a loan.
Should Life Insurance Be Part of Your Retirement Planning?
Term life insurance often plays a key role in estate planning. Your policy's death benefit could protect your family's financial future. Whole life insurance has additional benefits, but it isn't for everyone.
Pros of Using Life Insurance for Retirement Income
- Extra retirement income: Most retirees live on a fixed budget and rely on income from investments, Social Security, cash savings, annuities and other sources. Cash value life insurance could help you navigate a financial emergency. It can also provide extra money to use as you wish when you're no longer working.
- Tax benefits: You can usually tap your cash value without paying taxes, as long as the amount doesn't exceed what you've paid in premiums. In contrast, distributions from retirement accounts like 401(k)s and traditional IRAs count as taxable income.
- Flexibility: Your policy might allow you to use your cash value to pay your premiums or increase your death benefit.
Cons of Using Life Insurance for Retirement Income
- Lower investment returns: Life insurance companies typically pay dividends of 1% to 2% annually on a policy's cash value amount. Meanwhile, the average annual return for the stock market has been around 10% for the last century.
- Costs: Whole life insurance can be up to 15 times more expensive than a term policy.
- Reducing your death benefit: If you use your policy's cash value for retirement income and don't pay it back, your death benefit will be reduced. That could affect your family's financial well-being after you pass away.
Alternative Ways to Help Pay for Retirement
- Retirement accounts: Tax-advantaged accounts like 401(k)s and IRAs can provide retirement income and tax benefits. For example, 401(k) contributions are tax-deductible—and Roth IRA withdrawals are generally tax-free.
- Income annuities: After purchasing this type of annuity, you'll receive guaranteed cash payments in retirement—possibly for life. That can help prevent you from outliving your money.
- Social Security: Social Security benefits provide guaranteed monthly income payments. You can start collecting your benefit at age 62, but you'll get more if you wait until at least your full retirement age.
- Your emergency fund: You can draw on your emergency fund to cover unexpected bills in retirement. Most financial experts recommend keeping three to six months' worth of living expenses in a liquid savings account.
The Bottom Line
The cash value that accumulates in a whole life insurance policy can provide much-needed retirement income. The policy's death benefit can also give your family financial peace of mind. Think of life insurance as one of several potential income sources in retirement. Having other sources to draw on can reduce the chances of outliving your money.
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