Can I use life insurance to help me save for retirement?
Does every life insurance policy have cash value?
A "term life insurance" policy can be a great way to help protect your family, especially since many term policies are designed to be affordable. However, a term life policy does not build cash value and can’t help you with retirement. On the other hand, several types of “permanent life insurance” (including “whole life insurance" and “variable life insurance”) put part of the money you pay (the “premium”) into an account you may be able to eventually draw money from. Some people use that money to help pay for things like college education for their children. It’s also possible to use the money for retirement, and to pay less tax on the money if you do. (Before you go this route, you’ll want to talk to a tax expert to make sure you don’t pay more taxes than necessary.)
Ways to use life insurance for retirement
If your policy has built cash value over time, there are three ways you may be able to use it for your retirement. One involves completely cashing in your policy. The other two allow you to keep some or all of your life coverage but draw money from the policy. Remember that your ability to take some of the cash value from your life insurance will depend on the type of policy you have and how long you have paid into it.
1. Cash it in
You give up your life insurance policy, take the cash value from it, and use that money for your retirement. One option is to use the proceeds to purchase an annuity from your insurance company. The annuity is able to make regular payments to you over time. This ends your insurance coverage. In other words, your loved ones will receive no death benefit when you die. (Also, note that you may be required to pay “surrender fees” if you take this route.).
2. Cash part of it in
You arrange to have some (but not all) of the cash value of your policy paid to you. This way you still have some life insurance to help protect your loved ones. Keep in mind that the amount you cash you withdraw will be subtracted from the amount of money your loved ones will receive when you die. For example, if the amount of life insurance coverage you purchased was $25,000, and you arrange to have $10,000 of the cash value of your policy paid to you in an annuity, the payout from your policy when you die drops to $15,000. (Choosing this option also may mean you have to pay “surrender fees.”).
3. Borrow from it
If you have built up enough cash value, you may be able to borrow money from your policy and use it towards retirement. Remember that in this case you will have to repay the money along with interest on the loan. Your insurance company will add that interest payment to your regular payment for the insurance (the ”premium”). If you repay the loan, the amount of money your loved ones receive after your death is unchanged. But if you still owe money to the policy at the time of your death, it will be subtracted from the amount of the death benefit your loved ones receive. For example, if you have a life insurance policy worth $25,000, and you owe $5000 on your loan when you die, your loved ones will receive $20,000 (plus any unpaid interest your money has accrued).
Is using my life insurance policy for retirement right for me?
If you're close to retirement and already have a life insurance policy that has built good cash value, you may want to consider using that cash to help pay for your retirement. But you might want to balance your need for that retirement money against your need to help protect loved ones after your death, since in some cases using your cash value for retirement will reduce or eliminate the death benefit they receive. If possible, have other retirement savings in addition to your life insurance cash value. Don’t count on it to provide all the money you need.
If you’re young, life insurance that builds cash value may prove valuable in the years to come. But if you have lots of years of work ahead of you, there may be better ways to build retirement savings. For example, you might want to look into a tax-deferred program such as a 401(k) that is specifically designed for long-term retirement savings. Life insurance is still important—just not as your main retirement savings tool.
Whether you’re young, in the middle of your life, or looking at retirement, we suggest discussing your retirement savings program with a trusted financial advisor before you act.