Whole Life Insurance as a Supplemental Retirement Plan

October 24, 2018

IRA’s, 401(k) plans, profit sharing plans, and pensions all offer attractive benefits. However, there are limitations to the amount of contribution that can be made to these plans in any given year.

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Most Retirement Plans Offer Tax-Deductible Contributions

Of course, the trade-off here is that the distributions from these plans are generally taxable. The Roth IRA is an important exception. With a Roth IRA, the contributions are made on an after-tax basis and distributions are normally tax-free. However, there are limitations with respect to the amount one can contribute to a Roth IRA in any given year. In addition, a couple that is married filing jointly experiences a phase-out of their contributions to a Roth when their AGI exceeds $186,000. The phase-out starts for single individuals when their income exceeds $118,000.

Whether or not one qualifies for the Roth IRA, it makes good sense to diversify retirement assets.

One of the attractive features of whole life insurance is that while it can be a good supplement to retirement planning, it does not contain penalties for early distributions as some retirement plans do.

Whole life insurance has one feature that is similar in nature to a Roth IRA. Premiums paid to a whole life insurance policy are made with after-tax dollars. Distributions from a whole life insurance policy can be structured as tax-free distributions. Some important distinctions include:

  1. Money can be withdrawn from a whole life insurance policy for any reason without penalties.
  2. The limitations on contributions to Roth IRAs do not apply to whole life insurance coverage.

Whole Life Insurance Offers Tremendous Planning Flexibility

Referring to Jim Doe, the 35-year-old male that bought a $200,000 whole life insurance policy for some mortgage protection (and probably supplemented that coverage with a term policy for things like college funding and family income protection). At age 53, Jim purchased a new home with a 30-year mortgage of $320,000 at a 7% fixed rate. He may or may not have been able to get new term insurance, however, his whole life insurance had a death benefit that had grown to about $220,000. Therefore, he would only have to have purchased $100,000 of term insurance, instead of $320,000.

Now assume that he retires 12 years later at age 65. The Whole Life Insurance policy could be used as a source of tax-free income. In this example, it is estimated that a little over $10,000 per year for 15 years could be withdrawn with no out of pocket premiums required and the policy would still remain in force This assumes that premiums were paid until age 65 and is based upon the 2005 dividend scale (which is not guaranteed).

If Jim died at age 75, he would be 22 years into his mortgage. The balance of his mortgage would be about $156,000. The net death benefit (after taking $120,000 out of the policy) is estimated to be $207,000 at that time. That would leave about $51,000 after the mortgage was paid off.

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Recapping what Whole Life Insurance Did for Jim

He bought $200,000 for a premium of $2,286 per year at age 35.

  1. He was guaranteed that as long as he paid his premiums timely, he would get at least a $200,000 death benefit, cash value would start to build up after two years on a tax-favorable basis, and his premiums would never increase.
  2. When he bought a new home and carried a much larger mortgage of $320,000, he had in place enough life insurance to cover over 2/3 of his new mortgage, even if he was no longer insurable.
  3. No matter how large his cash value became, it could never get smaller (unless he took money out).
  4. There was never any market risk. He could always count on the money in his policy for emergencies. He could take some of the cash value out of the policy at any time.
  5. When he retired, he could have taken tax-free income in the amount of $10,000 per year and did not have to pay premiums out of pocket anymore.
  6. When he died at age 75, the remaining mortgage balance of $156,000 was paid off by the net death benefit and there was $51,000 of cash left over, all income tax-free.
  7. He had the option of taking out larger or smaller amounts of money at any time. He did not have to keep to the 15-year schedule. This could be especially important if market conditions were bad in some of his retirement years. For example, assume that he wanted a steady retirement income of $50,000, excluding Social Security. In very bad market conditions, as share values diminish, one needs to liquidate a lot more shares to get $50,000 (and one is selling low in the process). If market conditions improve significantly, one needs to liquidate far fewer shares to get $50,000 (and one is selling high in the process). Because his whole life insurance policy served as a supplemental retirement plan, he had the flexibility to take more money out of it in bad market years and less out of it in good market years.

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