Many people aren’t aware of the benefits and value life insurance can provide as part a retirement plan.
Life insurance is primarily viewed as a way for a family to safeguard their income in the event that a breadwinner passes away during their working years. It’s good if that’s the main reason an individual bought a policy. However, this income-replacement function does not have to end with retirement.
The financial situation of the spouse who has died in retirement can be difficult for the spouse left behind (most often the wife). Although living expenses may be lower if there is only one person in the household, it doesn’t always mean that income will drop. One of the two Social Security payments the couple was receiving will be lost or reduced to a minimum. Sometimes, the pension payment is reduced to 50% or 75% of its original amount. You can use life insurance to make sure there is enough money to cover the loss of income and allow your spouse to continue living comfortably in retirement.
Tax-free treatment
The tax benefits are what I love most about life insurance.
The tax code contains several provisions that provide life insurance income tax benefits and transfer tax benefits.
Benefits for death
Death benefits are usually paid income-tax free to beneficiaries. They may also be exempt from estate taxes if the estate remains below the taxable limit. The current limit is $11.4 million for singles and $22.8million for couples. However, state limits could be lower. These estate tax exclusions also apply to any assets that you pass on to your heirs.
Benefits for Accelerated Death
Benefits that are paid before the insured dies due to terminal or chronic illness are also exempt from tax. This option is called an “accelerated death benefit” (ADB). It is relatively new. ADB options may not be mentioned in policies that have been in place for many years by elderly people. If this option is offered, interested individuals should contact their life insurance provider. This coverage can be added to an existing insurance plan if it does not provide it. The insurance policy can have the additional benefit, but it may come at a price.
An ADB allows policyholders to receive a portion of their death benefits in advance. This is a major benefit. This option has no major drawbacks. However, policyholders must be either terminally ill or chronically ill to receive an ADB. Policyholders who need care have other options, including those who are terminally ill or chronically ill and those who aren’t.
Cash value
Permanent life insurance policies allow cash values to grow without income tax. Cash values that exceed the policy owner’s tax base can be borrowed income-tax free as long as the policy is in force. However, there are some drawbacks to this. The death benefit is used to pay the loan balance and interest if you die before the policy loan is paid back. If your beneficiaries require the full amount of the benefit, this could cause problems. The interest accrued on a loan that is not paid is added to its principal balance.
Your policy may be terminated if the loan balance exceeds the cash value. If a policy is canceled or lapsed, the loan balance and interest are considered taxable income by IRS. The amount of the original loan and interest earned could make the tax owed quite high.
There are always critics, just like any investment. There are risks involved in borrowing from an insurance policy. You should consult a professional to ensure that your policy is structured correctly for your purposes.
Many critics are misinformed or designed to steer people away form insurance and towards other investment options. Many advisors don’t recommend life insurance because they believe it is too costly. However, fees are a part of life insurance. The same applies to 401(k), traditional IRAs, and Roth IRAs. Any retirement savings plan will have fees.
Competitive fees
You don’t want life insurance to cost you more than it is worth. However, fees that are properly structured can be very competitive. The fees include surrender charges, administrative costs, and sales charges. Additionally, the underlying cost of insurance is high while you are young, but it increases as you get older. Brightscope estimates that the average annual expenses for large-company 401k plans is 1% of the account balance.
The expense ratios for mutual funds can be as high as 1.5% to 2.2%. Many mutual fund investments can cost between 2.5% and 3% annually. This does not include transaction fees, which are charged when the money manager purchases and sells within the fund.
The fees for properly structured life insurance contracts tend to be higher in the early years and lower during the latter years. However, they can drop as low as 1.5% over the course of the program’s life. The key is to properly structure the life insurance contract at the beginning.
The contract should contain as little as possible life insurance, while still being funded at the maximum level permitted by IRS guidelines. This will maximize cash accumulation and reduce expense. This maximum funding scenario ensures that your expenses as a percentage to overall contributions are as low as possible. Your expenses will not change, regardless of whether you contribute the minimum amount required to keep the policy in effect or the maximum allowed by IRS guidelines. The death benefit must be as low and as minimal as possible, while maximising contributions to achieve fees as low at 1.5%. The question is, are the benefits of having a life insurance contract more important than the inherent costs?
Life insurance fees can be compared to apples. This means that you pay more if your account balance is small and less if it is large. There are mortality fees associated with life insurance that can be used to support the life insurance benefit. Additional fees are charged to cover the costs of managing, underwriting, and establishing your account. These fees come with incredible benefits, including a death benefit and tax-free growth or withdrawals. You also get the power to index your funds to increase their value over time.
Many assets that are worth having, and which have the potential for creating wealth, come with transaction or acquisition costs. These include real estate or art, as well as gold or other precious metals.
Explore all options
Even if you’re not working, that doesn’t mean that you don’t need the benefits and protections life insurance can provide. Start by researching the benefits that the right policy can offer as part of your retirement strategy. It’s like any other investment. You need to determine your needs and find out as much information about insurance companies as possible. Then, get referrals to specialists who will help you understand the pros and cons of different policies.