Can Life Insurance Be Purchased Using Qualified Retirement Money?
Life insurance is a financial product that protects your family. Life insurance proceeds are paid out to a beneficiary when you die. Your premium payments and cost of insurance are determined by your health, age and lifestyle, as well as your gender. If you qualify for life insurance, one option you have is to pay for the premiums out of your qualified retirement account.
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Types
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There are two ways for you to purchase life insurance using qualified retirement plan money. First, you can purchase a life insurance policy inside of a qualified plan if your employer offers plans that will accommodate the purchase of life insurance (i.e., 412(i), IRA, etc.). The other way to purchase life insurance using qualified money is to purchase a life insurance policy outside of a qualified plan.
Function
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Buying life insurance inside of a qualified retirement plan allows you to purchase money with pretax dollars. Instead of you making contributions, your employer pays a portion of your income to the qualified plan's life insurance policy. Additionally, your employer can pay for your policy premiums, in addition to your regular pay. For policies not housed in a qualified plan, you withdraw money from the plan to pay for the premiums.
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Benefits
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The benefit of the qualified plan life insurance policy is that premiums are paid on a pretax basis to the company and death benefits are income tax free. This means that the life insurance policy premiums represent a tax deduction for the employer. Since you don't need to withdraw money from the qualified plan, no tax or penalties are due to pay your policy premiums. With life insurance policies outside of a qualified plan, you are not limited to the policy size you can purchase, and the death benefit can be many times the size of your qualified plan account balance.
Disadvantages
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The disadvantage to a qualified plan life insurance policy is that the premiums used to pay for policy premiums are taxed as income to the employee. This means that instead of deferring the income, the premiums are treated as current income. The business gets a tax deduction, but you do not. The disadvantage to a non-qualified life insurance policy is that you may incur penalties for withdrawing money to pay for the policy premiums. Taxes will be paid on any withdrawals from the non-qualified plan. In addition to this, you are charged a 10 percent early withdrawal penalty if you are under age 59 1/2.
Considerations
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Think about whether you want the ability to own your policy and make withdrawals from it, or if you want to leave it for a future benefit to your heirs. Qualified life insurance plans are subject to the same rules as other qualified retirement plans in terms of early withdrawal penalties and contribution limits. This limits the flexibility of a life insurance policy. Non-qualified life insurance plans are more flexible since you can borrow from any cash values inside the policy whenever you want and are not restricted on the total premiums you can put into the policy.
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