Aaron Cirksena is the founder and CEO of MDRN Capital.
Life insurance is commonly purchased to provide financial support for the policyholder’s loved ones in the event of an untimely passing. It acts as a legacy planning tool that can provide funds for much-needed expenses incurred by those left behind.
Yet life insurance can serve investors before their passing when it is used as part of a retirement planning strategy. As a retirement investment, it can improve a retiree’s financial capabilities in a number of ways.
The following pros and cons should be carefully considered to determine whether life insurance would be a good addition to one’s overall retirement strategy.
The Upsides Of Life Insurance In Retirement Planning
One of the primary goals of retirement planning is minimizing the retiree’s tax exposure. Retirement strategies carefully consider the best way to grow retirement wealth with minimum tax costs, using pre-tax deposits when most beneficial and converting to tax-free withdrawals when the time is right.
Depending on the type of policy, life insurance can provide tax advantages for retirement investors. Permanent life insurance, which offers lifelong coverage as long as the policyholder continues to pay premiums, provides both a death benefit and a cash value that grows over time.
Because the cash value of a permanent policy is tax-deferred, it facilitates more efficient growth than some other investment vehicles. Permanent life insurance also typically provides tax-free death benefits, which allow heirs to receive assets in a way that offsets estate taxes.
Permanent life insurance can also provide retirees with a source of liquid assets to supplement other retirement income since the policy’s cash value can be accessed via loans or other types of withdrawals. As long as the amount withdrawn does not exceed the total number of premiums paid—commonly known as the policyholder’s basis—it is typically tax-free.
The types of tax-free loans life insurance can provide may be becoming increasingly valuable to retirees. Research has found that 45% of American investors retiring at age 65 are at risk of running out of money during retirement, with experts saying a lack of tax preparation and high medical costs are two common issues that can drain retirees’ funds.
Another valuable upside to including life insurance as a part of retirement planning is the long-term care benefits it can provide. Certain life insurance policies offer riders that allow policyholders to draw on their death benefits to cover long-term care costs. In some cases, the benefits provided for long-term care are tax-free.
The Downsides Of Life Insurance In Retirement Planning
Cost is the most glaring downside to life insurance as an investment. Policies that provide the best benefits, such as permanent life insurance, require higher costs than policies like term life, which only provide benefits for a set period. Riders that provide long-term care benefits also add to the costs.
Premiums for life insurance also generally increase with the policyholder’s age. With some permanent policies, the amount policyholders must pay in premiums can increase annually.
Additionally, the return on investment offered for permanent insurance policies is a fixed rate. While this provides a more predictable return, it can’t compete with the rate of growth long-term investors typically experience in the stock market.
Another downside to using life insurance for retirement investing is a lack of flexibility. With a traditional or Roth IRA, investors have the flexibility to choose from a virtually endless number of investment options. With the majority of insurance policies, however, the choices are extremely limited. This can make it challenging for retirement investors to practice rebalancing, which is a valuable component of a long-term strategy.
Life insurance also provides less flexibility when it comes to accessing funds. Whereas all the funds invested in conventional retirement accounts such as 401(k)s and IRAs become accessible once an investor hits retirement age, the portion of life insurance premiums that go to death benefits typically remains inaccessible during the policyholder’s lifetime.
Complexity is yet another downside of life insurance. A broad range of factors can affect the amount of a policyholder’s premiums, including their age, lifestyle and health conditions. Additionally, premiums can increase annually with certain policies, and because policy costs are variable, it can be difficult for investors to determine the actual return on investment they are receiving.
Life insurance can be a valuable investment tool for retirement savers looking to improve their tax position; however, there are a number of downsides to consider, not the least of which is the potential to significantly increase investment costs. Before adding life insurance to their retirement portfolios, savers should carefully consider each of the pros and cons and evaluate how they could ultimately impact their earnings.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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