Cash Value Life Insurance can be used to provide retirement income that's tax-free as long as the policy is properly structured and funded.
What kind of Life Insurance works to fund a Tax-Free Retirement income?
The kind of life insurance that pays excess interest or dividends, above and beyond what is necessary to guarantee policy endowment.
There are two general types:
- Whole Life - fixed premium
- Universal Life - flexible premium
These two general types can be divided further into many sub-categories:
- Participating Whole Life - pays non-guaranteed dividends that add to the guaranteed cash values
- Interest Sensitive Whole Life - pays non-guaranteed excess interest above the guaranteed interest rate
- Current Assumption Universal Life - general account product *(this is the original form of Universal Life)
- Variable Universal Life - separate account product
- Indexed Universal Life - general account product
One of the most modern forms of life insurance today is Indexed Universal Life insurance where the interest credits to the policy cash values can be linked to the performance of an index, like the Standard & Poors 500. This new type of policy can be further sub-divided again into two more specific categories:
- Accumulation Oriented Indexed Universal Life
- Protection Oriented Indexed Universal Life
It is important to differentiate between these two products because one is designed for maximum cash value accumulation and the other is designed for a maximum death benefit for a given premium structure. Both products may have living benefit riders, such as Critical Illness and Chronic Illness, as well as riders that pay benefits for Long Term Care.
Even newer than Indexed Universal Life are a very small number of companies that manufacture Participating Whole Life with Indexed Dividends, where their dividends can be linked to the performance of an index, like the Standard & Poors 500.
As a rule, if your objective is Tax-Free Retirement income, then you probably want a policy designed for maximum cash value accumulation. If you aren't sure what kind of policy is appropriate, that is where a qualified insurance agent can help.
Red Flags to Avoid
- Any agent that says one type of policy is always better than another type of policy. With every policy design, there are trade-offs. Only you can decide which policy, or portfolio of policies, is right for your situation.
- Any agent that does not know how to properly design a life insurance policy for maximum cash accumulation and maximum distributions. These skills are rarer than one might imagine.
- Any agent that promotes the use of cash value life insurance for Tax-Free Retirement, or any other cash accumulation strategy such as using life insurance as a personal bank, that does not own what he sells. The best agents will show you their policies.
- Any policy that does not have an Overloan Protection Rider. This optional feature prevents the risk of premature policy lapse and the inherent tax risk that can arise from a policy lapsing before the insured dies.
Using Life Insurance as an Asset Class and Retirement Savings Plan to provide a Tax-Free Retirement income is generally suitable for people who have already maxed out their Roth IRA, their Roth 401(k) if available, who have at least ten years or more before they will need income, and who are in reasonably good health. In some cases, where a person's income isn't "earned" such as rents, bond interest payments, stock dividends, royalties, proceeds from the sale of real property, proceeds from the sale of stock or business interests, inheritances, gifts, lottery winnings, alimony, separate maintenance payments, or other windfalls, and therefore ineligible for contribution to a Roth IRA or other Qualified Plan, then using life insurance in lieu of a Roth IRA and Roth 401(k) may be appropriate.
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