Why would anyone use life insurance to supplement their retirement?  Life Insurance provides valuable death benefit protection.  But a properly designed cash value life insurance policy can also provide living benefits in the form of tax-free distributions.  Let’s look at some of the primary reasons why it is a valuable solution for many clients looking to save for retirement.

Tax Diversification

One of the primary reasons to use life insurance in one’s retirement planning strategy is for tax diversification. Before looking at why the tax-free advantage is important, let’s first look at what the options the client would have otherwise. A client has the option of three different traditional investments for funding of their retirement.  They can use a tax-deferred vehicle, like a 401(k).  They could fund a taxable investment like mutual funds, stock, and bonds.  And lastly, there are tax-advantaged assets like the Roth IRA and municipal bonds.  And any of these assets could represent a valid solution for a client’s retirement planning strategy. Life Insurance is just another vehicle to use with very specific reasons for doing so. One of those reasons is that the inside build-up of cash surrender value is not taxed.  Assuming the policy is a non-modified endowment contract, loans are not taxable either.  Having income that is tax-free can end being advantageous, especially if that client is in a higher tax bracket due to the amount of reportable income he or she earns in retirement.  When a client has a larger purchase during retirement, taking out a tax-free distribution from a properly structured life insurance policy could make a lot of sense. What happens when a client takes out a larger distribution from a 401(k)?  It is very possible that they could pay more in taxes due to being in a higher tax bracket. Just like an advisor who suggests a client should diversify their investment portfolio to hedge against certain situations, the same could be said about using life insurance to provide tax-free income in retirement.  It is acting as that hedge against increasing a client’s tax exposure.  One last benefit of having the income-tax-free is when one spouse dies.  In the U.S we have a progressive tax structure.  But we also have different filing statuses with our taxes.  When married and filing jointly, that helps to put one in a lower tax bracket potentially.  Once one spouse dies, that surviving spouse now has to deal with a potentially higher tax bracket.  By having an asset to pull tax-free income, he or she can help alleviate that exposure.  

Unlimited Funding Limits

Another reason to use life insurance to supplement a retirement plan strategy is for unlimited funding limits.  As long as your client can qualify financially for the death benefit being applied for, there is no limit on what can be saved in a life insurance policy.  For more affluent clients making well over $200,000 per year, saving $19,000 per year into a 401(k) might not be enough.  A Roth IRA might be a good option, but the max contribution is only $6,000 in 2019.  Add this to the fact that a married couple making $203,000 or more can’t contribute at all, and this appears to be a limited option.  With a properly structured life insurance policy, a client can select a contribution amount that fits their needs and budget and has the minimum death benefit solved for.  This way their policy is structured in such a way as to reduce the cost of insurance and maximize the ability to build cash value.  A client could certainly choose to use the traditional taxable investments for any contributions that are above qualified plan contributions.  But using life insurance adds some diversification, mainly the tax-free nature of distributions. But the death benefit can also be helpful, as a premature death can help to self-fund the surviving spouse’s retirement. A qualified plan left to a spouse is not as advantageous as it is fully taxable and if the contributing spouse died too soon, there won’t be enough to fund the surviving spouse’s retirement or help with lifestyle if still working.  The unlimited contributions can be very appealing to clients for all the reasons just mentioned. 


The last reason why life insurance can make sense for supplementing a client’s retirement plan is because of its flexibility.  In addition to the tax benefits and unlimited contribution limits, the client also has the ability to take distributions prior to 59 ½.  In fact, the client could take out income whenever they like, assuming the policy is in a healthy position to do so.  The client can also choose to never take distributions if they don’t need or want to.  There is no 70 ½ requirement to begin distributions.  The life insurance then becomes a wealth transfer asset.  Clients have goals that sometimes change over time.  To have assets that leave little wiggle room for change do not make much sense.   Let’s suppose that a client’s tax exposure is greatly reduced in retirement, but they are concerned about outliving their other income.  The beauty of the cash value in a life policy is that it can be exchanged to an annuity.  This is called a 1035 exchange and will have no tax consequences on the gain.  Lastly, a max funded life insurance policy can be a strong alternative to a long-term care policy.  Clients that have saved money in a life policy but can’t qualify for long-term care coverage, could use the tax-free distributions to pay for care in a facility.  Although this is probably not the reason the client took out the policy, it another benefit. 

To summarize, a properly structured life insurance policy can be a strong option for clients looking to supplement their retirement plan.  It can provide a hedge against unwanted tax exposure at a time where we have uncertainty in the political arena.  Who knows where taxes end up in the future. In addition, this strategy provides a solution to affluent clients looking to contribute more for their retirement but have limited options after max funding their qualified plans.  And lastly, there is flexibility in this strategy that can provide for a client’s changing goals.