If you’re looking for a way to create a steady stream of income in retirement, you may want to consider using your life insurance policy. With some smart planning, you can turn your life insurance into an income stream that provides regular payments, similar to an annuity.
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Here’s how it works and why it might be a good option for your retirement (or really anytime) income plan.
The Power of Cash Value Life Insurance
The key is having a permanent cash value life insurance policy like whole life, universal life, or indexed universal life insurance. These policies build up a cash value over time that you can access while still keeping your death benefit coverage intact.
With whole life insurance, the cash value grows at a guaranteed rate set by the insurance company based on the premiums you pay. Universal life policies allow you more flexibility – the cash value grows based on current interest rates and you can adjust your premium payments.
Indexed universal life (IUL) ties the cash value growth to a stock market index like the S&P 500, giving you the potential for higher growth than traditional whole life when markets are up. However, IULs also have a minimum guaranteed interest rate to protect your cash value when markets are down.
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Tapping Into Cash Value
Once you’ve built up sufficient cash value, usually after 10-15 years or so, you can start taking loans, withdrawals, or even annuitize your policy to turn that cash value into an income stream for life.
“Taking loans from the cash value allows you to receive income on a tax-free basis since you are just borrowing your own money,” explains Ted Rosen, a life insurance specialist in Miami.
Withdrawals are another option up to your cost basis (premiums paid) which is tax-free income. Or you can choose to annuitize the full cash value which converts it into a guaranteed income stream similar to an immediate annuity.
Advantages of Universal Life for Income
Both universal life and indexed universal life insurance offer advantages if using the policy for retirement income planning:
- Flexibility to adjust premiums makes it easier to build up cash value
- Option for loans and withdrawals gives you access to tax-advantaged income
- Cash value grows tax-deferred
- Death benefit is paid income tax-free to beneficiaries
ALSO READ: Who Keeps the Cash Value When You Die?
“The cash value growth and income options of universal life make it a very versatile asset for retirement income planning,” says Justin Bryant, an IUL specialist at Annuity Gators in Florida.
Example of Income Stream
Let’s look at a hypothetical example of how this income stream might work:
John, age 55, has a $500,000 indexed universal life insurance policy with a cash value of $200,000. He decides to take out a $10,000 loan each year from the cash value, allowing him to receive that amount as tax-free income.
He can continue taking out loans until the total outstanding loan amount approaches the policy’s cash value. At that point, he could choose to pay back the loans or let the insurer recover the loan balance from the death benefit when John passes away.
With this strategy, John is able to access an income stream worth $10,000 annually for life from the cash value of his life insurance policy, supplementing other income sources in retirement.
Proper Planning Is Key
While turning life insurance into an income stream has its advantages, there are some important considerations:
- Outstanding loans eventually get paid back from the death benefit owed to beneficiaries
- Income stream stops if cash value is depleted
- Lapsing the policy may result in taxable income on outstanding loans
“It’s critical to work closely with an insurance specialist to model out different scenarios and income stream options based on your specific policy and retirement goals,” advises Bryant.
By carefully integrating life insurance cash value into your retirement income plan, you can create a valuable income stream to cover expenses in your later years. With its tax advantages and flexibility, cash value life insurance deserves a look as part of a diversified retirement strategy.
