Whole life insurance with a cash value component can offer similar tax advantages to a Roth IRA. But to get the biggest savings for retirement, an IRA or traditional retirement account is the best option.
Saving for retirement typically involves a 401(k) plan through your employer or an individual retirement account (IRA). But there are some people use a permanent life insurance policy with cash value to build retirement savings.
Using life insurance as an investment tool isn’t the best primary choice for retirement savings because it can be costly to build cash value and maintain a policy. But if your employer doesn’t match contributions or if you’ve maxed out your annual contributions, permanent life insurance may be a good supplemental option for you.
Learn when using life insurance as an investment makes sense and the important differences between Roth IRAs and life insurance to decide which retirement savings plan is the best choice.
Life insurance vs Roth IRA
Using life insurance to save for retirement is known as having a life insurance retirement plan (LIRP). This type of plan uses a permanent life insurance policy’s cash value component to help fund retirement.
An IRA is a retirement savings plan that you open and fund on your own and one of the simplest ways to save for retirement. IRAs are ideal for those without employer-sponsored plans, such as 401(k)s, but can be used in addition to other retirement savings.
Both LIRPs and IRAs are individually funded (with no involvement from your employer), so deciding between the two makes sense. But in most cases, an IRA is the best first choice between the two and a LIRP is the best choice if you already have an IRA and have reached your annual contribution limit.
Tax benefits
LIRPs have the same tax benefits as a Roth IRA, so you don’t pay taxes on withdrawals after age 59 ½ and cash gains are tax-deferred. The difference between Roth IRAs and traditional IRAs is the tax structure. Traditional IRAs are non-qualified, meaning you use pre-tax dollars to contribute and pay taxes upon withdrawal. Roth IRAs are qualified, meaning you use after-tax dollars to contribute and do not pay taxes on withdrawals after age 59 ½.
Whole life insurance, or any other type of permanent life insurance with cash value, can help fund retirement.
IRA vs 401(k)
IRAs and 401(k)s are both great ways to save money for retirement. The main difference between an IRA and 401(k) is whether your employer is involved. An IRA is only available to individuals, similar to permanent life insurance, while 401(k)s are employer-sponsored and often offer some sort of employer matching.
401(k)s allow higher yearly pre-tax contributions than IRAs, but have fewer investment options.
See how life insurance compares with a 401(k) and Roth IRA below:
Tax comparison: LIRPs, traditional 401(k)s, and Roth IRAs
How permanent life insurance can be used for retirement
A cash value life insurance policy can supplement other retirement savings accounts, but we don’t recommend using life insurance as your main savings vehicle. However, if you’ve reached the contribution limits for your 401(k) or IRA, here’s how putting money into your permanent policy’s cash value can be beneficial:
Pay extra premiums to fund your cash value
Overpaying your permanent policy’s premiums means the extra money paid goes into the cash value and grows tax-deferred. But there are some caveats: you’ll be penalized on withdrawals before age 59 ½ and if you exceed the annual premium limit (set by the IRS) your policy converts into a modified endowment contract (MEC) (which means extra taxes and penalties for withdrawals.)
Use the cash value to supplement retirement
As a cash value life insurance policy owner, you can access the cash value in addition to your retirement accounts, allowing you to spread out retirement spending across multiple accounts. For example, after a down year in the stock market, you can withdraw money from your policy’s cash value instead of drawing down from your IRA, which will replenish your IRA savings.
Long-term care support
Most life insurance policies allow for add-ons called riders, including a long-term care rider, which provides an accelerated death benefit. It can be used as you age to pay for a nursing home or other medical costs related to long-term care.
Should you use life insurance as an investment?
If you max out your retirement accounts such as a 401(k) or IRA each year and don’t want to put additional funds into a traditional post-tax investment account, then using permanent life insurance to save can be a good option.
But if you’re trying to decide between opening an IRA (Roth or traditional) or opening a life insurance policy for the sole purpose of retirement savings, an IRA is almost always the better choice.
A Roth IRA offers higher returns on your contributions than cash value accounts and is much more straightforward than permanent life insurance, which can come with costly policy surrender charges, high premiums, and savings that aren’t guaranteed.
By: Rebecca Shoenthal
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