Life Insurance & Retirement
Some life insurance policies help you save money for retirement. These policies provide a traditional death benefit, but they also provide a savings feature. There are no contribution limits on these policies, so they're ideal for times when you have made the maximum legal contribution to your IRA or 401(k) plan but need to put more money away for your retirement.
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Type
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There are several types of contracts you may use when planning for retirement using life insurance. In all cases, you'll be using a permanent life insurance policy. A permanent life insurance policy is designed to stay in effect for your entire life. Contrast this with term life insurance, which stays in effect for a set number of years. A permanent policy is necessary when using life insurance as a retirement planning tool, since the policy must remain in effect the entire time you are retired to provide an income to you. These policies include whole life insurance, variable life insurance and universal life insurance. These policies all have a death benefit like term insurance. However, a cash reserve also accumulates in the policy, which is a feature not found with term policies. This cash reserve, called a cash value, serves as savings to be used during retirement.
Function
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All permanent life insurance policies are cash value policies. Policies suitable for retirement income planning generally focus more heavily on the buildup of the cash reserve. For this reason, a dividend-paying or interest-sensitive whole life policy and a universal life policy designed to minimize the death benefit and maximize the cash reserve function of the policy would be used. All variable life policy designs are suitable for strong cash reserve accumulation.
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Benefit
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By using a life insurance policy for retirement, you receive the benefit of income tax--free cash values of the policy. The cash value is not taxed as it builds up in the policy. Furthermore, you may withdraw from or borrow against the policy's cash reserve at any time during your life for any reason. This includes withdrawals and policy loans during retirement to supplement other income sources. The insurance policy premiums you pay are not tax-deductible as traditional retirement account contributions are, but withdrawals up to your cost basis are tax-free. Your cost basis is the total amount of premium you pay into the policy. All policy loans are also income tax--free as long as the policy remains in effect.
Warning
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Access to cash value through policy loans comes with risk. If the policy ever lapses, you will be taxed on all money that exceeds your cost basis. This money will be treated as a gain subject to ordinary income tax.
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