Life insurance helps provide financial security for loved ones if the unexpected happens to you. Yet, in addition to offering a death benefit that can protect loved ones when you pass, whole life insurance can also accrue cash value.

Although any life insurance policy is not a substitute for a well-funded retirement account, cash value life insurance can provide a source of supplemental income in retirement. Here’s what you need to understand about whole life insurance and its potential uses as part of a broader retirement plan.

How to use life insurance to pay for retirement

The best way to depend on life insurance for retirement income is by purchasing whole life insurance coverage. When you pay premiums for whole life insurance, a portion goes towards the cost of insurance, while another portion contributes to the cash value. Over time, this cash value grows on a tax-deferred basis, meaning you won’t pay taxes on the gains as long as they remain within the policy. This tax-deferred growth can be particularly advantageous for retirement planning.

As you approach retirement, you can begin to tap into the cash value of your whole life insurance policy. One way to do this is through withdrawals from the cash value of your policy. Withdrawals up to the amount of the premiums you’ve paid into the policy, known as the cost basis, are typically tax-free. Withdrawals above the cost basis may be subject to income taxes.

Another option is to apply for policy loans, but this isn’t possible if your life policy is a modified endowment contract. These loans allow you to borrow against the cash value of your policy at relatively low interest rates. Since the money you receive is a loan, it is generally not considered taxable income. But you must be careful with this option because unpaid loans and interest can reduce the life insurance benefit your loved ones will receive. Additionally, if the loan balance grows too large, it could result in policy lapses, where the policy is terminated, leading to tax consequences and loss of coverage. Therefore, it’s crucial to have another source of income to repay the policy loans, such as Social Security benefits, a pension, or withdrawals from a retirement account like IRA, 401(k), and emergency fund.¹

Do you need life insurance in retirement?

If you’ve obtained a level of financial freedom in retirement, you may not think a life insurance policy is worth it. However, that couldn’t be further from the truth.

Life insurance in retirement (both a whole life and term policy) offers a death benefit that your loved ones can use for any reason. Even if major debts like a mortgage are paid, your family can use the money to replace income while they grieve, pay for funeral expenses, or cover medical bills.

What are the benefits of having whole life insurance in retirement?

There are a few benefits of having a whole life insurance policy as a retiree. Some of the most important benefits are:

Protection lasts a lifetime

Unlike term life insurance, whole life insurance does not have an expiration date. So long as you’re paying your insurance premiums, your whole life insurance will cover you. Additionally, whole life insurance plans have fixed premiums. Since most retirees are on a fixed budget, having a predictable insurance premium is incredibly beneficial.

Cash value has a guaranteed rate of return

Many people make the incorrect assumption that the whole life cash value of their policy increases only due to the premiums they pay. However, the cash balance of your whole life policy will grow tax-deferred at a rate predetermined by your insurer.

While the rate at which your cash value grows may not keep pace with the stock market in some years, it will also not be affected by market risk, such as volatility. This means that when there are down years in the stock market, you can count on your policy’s cash value to grow steadily.

Distributions of premium payments are tax-free

Whole life insurance policies let you enjoy tax benefits, such as tax-free distributions. If you decide to take a distribution from the cash value of your policy, you won’t have to pay income tax, so long as you’re taking out the premiums you’ve paid in and not any gains. This feature can be particularly advantageous in emergency situations where you need immediate access to cash.

For example, imagine you are 65 years old and face an unexpected medical emergency that requires $30,000.

Whole life policy:

• Premiums paid: $100,000
• Cash value: $150,000
• Amount withdrawn: $30,000

Since you are withdrawing $30,000, which is within the premiums you have paid into the policy, this amount is considered a return of your cost basis and is tax-free. You do not owe any income tax on this withdrawal.

Use cash value for any reason

One of the benefits of a whole life insurance policy is that the policy’s cash value can be withdrawn for any reason. This means you can withdraw money from your policy to pay for anything, from everyday expenses, like healthcare, to financing leisure activities, like a vacation. This makes whole life insurance policies a way to save for retirement while providing you and your family peace of mind.

Flexibility in loan repayment

Unlike traditional loans, which have fixed repayment schedules and monthly payments, policy loans from a whole life insurance policy do not require a set repayment plan. You can repay the loan on your terms, whether that means making regular payments, occasional payments, or deferring repayment altogether.

Moreover, because you are borrowing against the cash value of your own policy, there are no credit checks or lengthy approval processes involved. This access can be particularly beneficial in retirement when fixed incomes or other factors might affect your creditworthiness.

Dividend Payments

Many whole life policies from mutual insurance companies pay dividends, which you can use to increase the cash value, reduce premiums, or take as cash. While dividends are not guaranteed, they can significantly enhance the overall return on your policy.

What are the downsides of depending on whole life insurance policies for retirement income?

While there are benefits to using whole life insurance to help plan for retirement, there are some drawbacks to consider. Below, we discuss the two most prominent drawbacks to whole life insurance.

Withdrawals will decrease the death benefit

Although the ability to withdraw from your policy’s cash value sounds great, it’s important to remember that withdrawing from your cash value will decrease the death benefit. This means if you withdraw most of your plan’s cash value without replacing it, you will reduce the amount of money your family receives upon your passing.

This doesn’t mean you shouldn’t use your policy’s cash value; just be sure you understand the ramifications of making withdrawals. Always consult a financial professional or tax attorney before withdrawing from a cash value life insurance policy.

Premiums can be costly

Using whole life insurance for retirement planning can be expensive, especially compared to alternatives, like term insurance. However, it’s important to remember that you can’t build cash value with term life insurance. This is a benefit only available to whole-life policyholders, which is reflected in the cost of premiums.

Should you get whole life insurance?

When choosing life insurance, you should do so with financial protection for your loved ones in mind. While some people may find the benefits of whole life insurance make it a great choice, others may find that a more affordable term life insurance policy is a better option.

Any retirement plans you make, including getting life insurance, should be done alongside a trusted financial adviser. If you’re ready to explore life insurance options, a licensed insurance agent is available to understand your unique financial situation and help you find the right policy for your needs and budget.

Find a policy that works for you

There are a range of affordable Fidelity Life products to choose from based on your situation and financial responsibilities.

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FAQs about using whole life for retirement

Is whole life better than a 401(k)?

Unfortunately, as with any financial matter, the answer to this is going to depend on your own personal circumstances. Generally speaking, life insurance is not a suitable alternative to a 401(k) or IRA. Insurance plans are designed to provide insurance first and foremost. The ability to use them as a retirement savings vehicle is an added benefit.

A well-rounded retirement planning strategy will incorporate tax-advantaged savings accounts, insurance, and potentially other savings vehicles. Before making any 401(k) or life insurance decisions, you should always consult with your financial adviser. They will be able to make the best recommendation for your unique circumstances.

At what age should you get whole life insurance?

As with most types of life insurance, securing a policy when you’re young and healthy results in the most favorable rates. For instance, you pay lower premiums and lock in those rates for the life of the policy. With whole life, buying a policy while young also gives your policy plenty of time to accrue cash value.

If you’re over 50 and don’t have a whole life insurance policy, don’t worry, it’s not too late to apply for one. Fidelity Life offers RAPIDecision^® Senior Whole Life, a low-cost, whole life insurance policy for people between the ages of 50 and 85. This specialized policy allows you to get up to $150,000 in lifelong coverage with a level premium and no medical exam.

Are there tax implications for using whole life insurance in retirement?

Generally, no. The cash value account in your whole life policy grows tax-deferred, and policy loans are generally tax-free. Withdrawals up to the amount of premiums paid are also usually tax-free. However, if the policy lapses and your withdrawals exceed the premium payments, it can result in taxable income.

Can I use term life insurance to plan for retirement?

Term life insurance is generally not designed for retirement planning, as it provides coverage for a specific period and does not accumulate cash value. Its primary purpose is to offer financial protection to your beneficiaries in case of your untimely death during the policy term. For retirement planning, whole life insurance or other permanent life insurance policies with cash value components are typically more suitable.

Additional considerations

When using life insurance retirement plans as part of your retirement strategy, there are several things you should consider so as to maximize the benefits. These include:

Combine whole life policies with other retirement plans

Depending on just whole life insurance for retirement income is setting yourself up for failure. This is because while whole life insurance is primarily for providing valuable benefits, such as lifelong coverage and tax-advantaged cash value growth, it typically doesn’t offer the high returns of other investment vehicles. These returns may not be sufficient to cover all your retirement needs, particularly if your expenses are significant or if you encounter unexpected financial challenges.

Therefore, it’s recommended to combine life insurance retirement plans with growth-oriented accounts like 401(k)s, IRAs, and profit sharing plans. This approach allows you to balance your investment portfolio with the security of guaranteed returns and the growth potential of market-based investments.

Purchase riders and additional benefits with your life policy

Many whole life insurance policies offer optional riders that can enhance your coverage and provide additional benefits. Common riders include:

• Waiver of premium rider: This rider waives premium payments if you become disabled and are unable to work, ensuring your policy remains in force even if you can’t make payments.
• Guaranteed insurability rider: This rider allows you to purchase additional insurance coverage at specified times without undergoing a medical exam, providing flexibility as your insurance needs change.
• Accelerated death benefit rider: This rider permits you to access a portion of your death benefit early if you are diagnosed with a terminal illness. You can use these funds for medical expenses, living expenses, or any other needs.
• Long-term care rider: This rider allows you to use a portion of your death benefit to cover long-term care expenses, such as nursing home care or in-home care.

Case study

For example, Sarah, a 30-year-old marketing manager, is looking for ways to secure her financial future. She has a 401(k) through her employer and a Roth IRA, but she wants to diversify her retirement savings with a stable, long-term solution that also provides life insurance coverage. After consulting with a financial advisor, Sarah decides to purchase a whole life policy with the following features:

• Death benefit: $500,000
• Annual premium: $5,000
• Cash value growth: Guaranteed rate of 4%

By the time Sarah reaches retirement age of 65 years, the policy’s cash value will have grown significantly to allow for withdrawals. Let’s break down the accumulation:

• Initial premium payments: $5,000 annually for 35 years = $175,000.
• Projected cash value at age 65: With the guaranteed growth rate and reinvested dividends, the cash value of Sarah’s policy is projected to reach approximately $300,000.

Sarah can make tax-free withdrawals up to the total amount of premiums paid ($175,000). For instance, she can withdraw $10,000 annually for the first 10 years of her retirement, totaling $100,000. For additional income, Sarah can take out loans against the remaining cash value. Assuming she withdraws $100,000, the remaining cash value would be approximately $200,000.

Conclusion

At the end of the day, yes, you can use life insurance to pay for retirement but it needs careful planning. Remember that while you can withdraw from your cash value account in whole life insurance policies, managing withdrawals and loans responsibly is crucial to maintain the policy’s long-term benefits for both retirement income and legacy planning. Moreover, it’s essential to integrate whole life insurance with other retirement savings strategies, such as 401(k)s and IRAs, to ensure a diversified financial plan.

Just hit your 50s and considering whole life coverage? You’re in luck because, at Fidelity Life, we have a type of whole life insurance designed just for you. With RAPIDecision^® Senior Whole Life, we guarantee level premiums for the entire life of the policy and coverage amounts ranging from $10,000 to $150,000. While we can only pay full death benefits if you pass three years after you buy the policy, you get to enjoy partial coverage immediately after paying your first premium payments. Even better? We don’t require you to take medical exams, unlike other insurance companies.

Get a free quote from Fidelity Life here or contact one of our agents at 1-866-746-6461 to get additional details about RAPIDecision^® Senior Whole Life.

Article Sources:

1. Forbes Advisor. “Is Life Insurance Taxable?, https://www.forbes.com/advisor/life-insurance/is-life-insurance-taxable/”