Though many may think it: Roth IRAs and 401(k) plans aren’t your only sources for tax-free income during your retirement years.
Permanent life insurance is a policy that holds an interest-bearing account, which is cash value that accumulates without having to be taxed. To boot, the rate of interest you will build will probably overshadow what you would receive with a normal savings account.
Glenn Daily, a fee-only insurance advisor in the state of New York, stated that is has been one of the best-fixed income investments because the cash value account grows more than 4 percent every year.
It is a low-risk and tax-deferred fixed-income investment with easy access to policy loans for those that are interested.
A policy loan on life insurance can offer policyholders a source of tax-free income through their retirement years.
However, there is a risk that if you do not do this correctly: you can be liable for taxes, and you might ruin the policy for actual use.
Permanent life insurance is often the choice, as it tends to shield the beneficiaries from estate taxes. The reason is that the coverage does not change as long as the premiums are paid for, and the life insurance payment is tax-free.
On top of that, permanent life insurance generally has a savings account, which can be nurtured in a variety of manners. Below are a few different types:
Whole life provides a cash value account that develops at the insurance company’s guaranteed interest rate.
Some customers are paying a dividend that they can use to buy extra coverage. For the entire period of the policy, clients pay a fixed premium.
Universal life also has a cash value account that grows on the principle of the company’s defined minimum interest crediting rate. If the underlying investments of the client does well, the insurance company may pay extra interest on your cash value.
This can come in handy when unforeseen bills and expenses come up from time to time. Unlike a 401(k), if you use the cash value from your life insurance, you would avoid a tax bracket bump.
With universal life insurance, customers can pay flexible premiums which implies that if your cash value is enough to cover the expenses of the policy, it can pay for your policy.
Insurance companies tend to provide different types of universal life policies, such as having your cash-value account invested in an index. Another form of permanent life insurance is variable life, which connects your cash value to investments that are similar to mutual funds. Generally, these are called subaccounts.
Although there are cheaper alternatives like term insurance, it only lasts about one to three decades. Permanent life insurance can be higher than a term insurance premium but will last throughout your life.
For example, NerdWallet says that a man, age 30, can pay just under $3,000 a year for a $1 million policy that lasts for three decades. On the other hand, a 50-year-old man can pay around $22,000 for the same policy that covers the rest of his lifespan.
If you were to take funds from your insurance policy up to the sum you initially invested, you would obtain it tax-free. However, any earnings that are withdrawn can be taxed as income. That is why loans are a popular strategy to use the policy as collateral as it is tax-free.
Jason Wellmann, head of life insurance distribution at Allianz Life, says, “I don’t see it as a primary investment that you should put all of your funds into. Rather, it’s a compliment, whether it’s retirement or emergency funding.” ⠀
Also, the repayment interest level is usually small— Daily pays 4.29% —which is a vast difference compared to the high rate of 17.7% interest rate on a credit card or 36% on a personal loan.
One reason for borrowing from your cash value account may be to handle your modified adjusted gross income and reduce the cost of Medicare.
That’s because retirees with a MAGI that tops $85,000 will have to pay high Medicare Part B premiums if single. The limit is$170,000 if married and registering together.
Receiving the loan will not put you in a higher income tax bracket, as most loans do. Using your 401(k) as well could put you in a higher bracket, and you would have to pay income taxes.
The loan from your cash account can be a handy tool when unforeseen financial issues come up.
However, be cautious and aware that borrowing from your policy, especially when you take loans and don’t repay them, because it can destroy your insurance policy.
Things can go wrong when clients borrow too much, and they cannot pay the premiums and interest of the loan. Those costs can eat up the policy. And if the person stopped paying the monthly premiums and the policy lapsed, they would be liable for taxes.
For example, if your policy has a cash value of $200k and you paid $100k in premiums, you end up paying revenue taxes on the $100k difference between your initial investment and the cash value.
Also, a thing to remember is that the latest action by the Federal Reserve to cut an important interest rate — as well as the trend of reduced interest prices — has an impact on the insurance companies. Some people invest in bonds, and long periods of small interest rates have an impact on the yield they receive.
Bond portfolios can not invest efficiently and safely at a greater rate as they mature. When that situation occurs, the crediting rate is brought down. If you end up in a three year period of lowe interest rates, where the rate you pay on the loan is higher than the crediting rate, your policy will be upside down.
Comparably, variable life insurance policy owners who receive substantial loan amounts from their accounts must be aware of how they might be affected by a long term drop in the market.
If you believe in having a buffer between the value of the account and the amount of the loan, that cushion degrades when the value of the account goes down. That can be a risk where the loan will impact the policy’s performance if a negative manner. If you already have cash value life insurance, be sure to review your cash value account with your financial advisor and ensure that is performing well and headed in the right direction.
If you have a loan from the policy, be sure to review the contract yearly with your advisor.
However, many financial professionals advise that you should not purchase a cash value life insurance for the sole reason of using it for retirement income. Life insurance should only be bought because of when it is needed.