Can life insurance provide retirement income?

Can life insurance serve as a source of retirement income? If your children are grown and your mortgage is paid off, the necessity of maintaining life insurance coverage becomes contingent on your individual circumstances. For many individuals, a cash-value life insurance policy, such as whole life or universal life, can emerge as a valuable and tax-efficient avenue for retirement income.

Utilizing the cash value of your policy allows for a potential reduction in withdrawals from retirement accounts, such as IRAs and 401(k)s, particularly during periods of financial market downturns when liquidating assets at decreased prices may be undesirable.

Essentially, you can leverage the cash in your policy through various means:

1. Withdrawals: You can generally withdraw a portion of the cash value without losing coverage. These withdrawals are usually not subject to income taxes up to the amount you’ve invested in the policy (i.e., the premiums paid). However, exceeding this amount may incur taxes, and withdrawals diminish both the death benefit and cash surrender value.

2. Policy Loans: Instead of a withdrawal, you can opt for a loan, which often involves a simpler process and lower interest rates than traditional bank loans. While policy loans may not be taxable, unpaid balances, including interest, may incur taxes. Additionally, outstanding loans can impact the death benefit.

3. Cashing Out: Surrendering the policy allows you to receive the entire cash value along with accrued interest, minus amounts required to cover policy loans, unpaid premiums, and surrender fees. However, any amount exceeding the cash basis (total premiums paid) is subject to taxation as regular income.

4. 1035 Exchange: Through a Section 1035 Exchange, you can transfer your life insurance policy to an annuity, structured to provide a lifetime income stream. While the exchange itself is not taxable, surrender charges may apply.

Considering the potential tax implications, it is advisable to consult with a tax advisor before making decisions. Additionally, ensure you are comfortable with potential reductions or eliminations of the death benefit, taking into account the financial needs of your spouse or family. Life insurance remains a valuable asset, serving not only as a potential source of retirement income but also as a means to cover final expenses for your family, such as funeral costs and unpaid medical bills. Maximize the utility of your cash-value life insurance policy by carefully considering your options.