10 August 2013 0 Comments

Taking Advantage Of Life Insurance Taxation At Retirement

retirement planningIn earlier entries I’ve shown how life insurance can produce very attractive tax free returns as a supplement to retirement.  This concept is based on creating a policy rich in cash values relative to its death benefit and then systematically withdrawing cash value up to the basis, followed by policy loans at (or close to) a zero-net-cost interest rate.  As long as the withdrawals/loans do not strip the policy of so much value that it lapses, all withdrawals and loans made during the life of the insured are received free of any tax and the death benefit going to the beneficiaries is income tax free.

At retirement, the features most people want from their assets is maximum, after-tax income and possibly the ability to leave a legacy for their families. The after tax income is much more important than the gross value of the assets.  The tax free feature is doubly important since taxable income can have a negative effect on Social Security retirement benefits. Withdrawals and loans from life insurance policies have no negative impact on net Social Security payments.

This can be an attractive financial planning tool for retirement, especially taking into account the current breed of Indexed Universal Life (IUL) policies available. The growth of the cash values in these policies is tied to outside indexes such as the Standard and Poor’s 500 which, over years have had a very attractive rate of return.  The tax free return becomes even more attractive when you consider what might be saved on premiums that would otherwise have been spent on term insurance.

I’m not suggesting that IUL policies be used in lieu of term in order to provide the maximum death benefit protection required.  Rather, once you have determined the appropriate amount of death benefit for your family setting, have provided for that protection with term insurance and are now ready to begin saving for your retirement, you can replace a portion of the term insurance with IUL further enhancing the tax-free return of the IUL policy.

My rules for using IUL as a retirement supplement are:

  • Maximize the premium and minimize the death benefit using term insurance for any additional protection requirements
  • Don’t flip from one index to another to try to take advantage of market conditions.  Pick an allocation and stick with it
  • Manage your policy after you start taking income to be sure the policy doesn’t lapse.

Let Uncle Sam help with your retirement needs.

Coming up… answers to the questions I’ve most often been asked over the years.

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