Should I Use Life Insurance for Retirement Income?

Permanent life insurance is sometimes discussed as a way to save for retirement. Whether it's variable, universal, whole life, or some other hybrid life insurance policy, these vehicles are sometimes touted for their tax-deferred potential and as a way to borrow money tax-free—a portion of the premiums go into an account that builds cash value along with the death benefit.

Borrowing money from life insurance may look appealing because of the tax benefit, especially if you need a loan due to a job loss or some other pressing need. But when it comes to creating a retirement plan using life insurance, investors may want to consider alternatives. It's worth it to weigh the differences, for example, between investing in your 401(k) versus life insurance for retirement.

For starters, the inherent cost of life insurance within any kind of permanent life insurance policy can become very expensive to continue.

Sometimes the ongoing expense of a life insurance policy can eat up its investment value. People in their 80s or 90s sometimes let the policy lapse because it may no longer serve a purpose in their financial plan. However, if the policy lapses, the tax-advantage withdrawals become taxable in the year the policy ended—and lot of people don't realize that.

Here are three ideas to consider when balancing your insurance needs and retirement.

Term life insurance can be significantly cheaper than permanent life insurance. Because of all the variables that come with life insurance—age, gender, health, family history, and more—it's impossible to say just how much cheaper, but the difference can be significant.

The primary use for insurance is to protect people who need to guarantee that certain expenses get covered, such as ensuring children can go to college or paying off your mortgage. If you pass away early and your partner or spouse loses your income, then you need some protection to make sure those expenses still get paid.

In addition to keeping your family protected and paying off your debt, term life insurance allows you to use the savings in your policy to invest. Just be diligent about it. Pay yourself first by enrolling in automatic deposits to your retirement accounts, maxing out your contribution limit, and contributing enough to get any available employer match. If your employer offers a health savings account, you can also save money there for medical expenses now or in retirement.

If you're weighing whole life insurance versus an IRA, think about a Roth IRA as well. Insurance premiums aren't tax-deductible, and although you don't get a tax break when investing in a Roth IRA either, your tax benefit comes on the back side when you withdraw your gains tax-free. Of course, a traditional IRA often offers a tax break when contributions are made, and the decision between a traditional and Roth IRA is one individual investors need to make carefully.

Traditional and Roth IRAs have some restrictions and tax penalties when a person withdraws money before age 59½ that permanent life insurance policies don't necessarily have.

In an insurance policy, such as universal or whole life, the returns are traditionally fairly low because the policy pays dividends and interest. With variable life policies, those investments tend to be somewhat expensive and limited.

The idea behind insurance is protection, and an annuity can offer its own protection by guaranteeing income in retirement, especially as you get closer to retirement when you'll need income to replace your paychecks.

There are several types of annuities available, with the most basic being a single premium immediate annuity. You pay the insurance company a set amount—say, $100,000—and the company pays you a fixed amount on a regular basis (monthly, quarterly, or annually) that's guaranteed for the rest of your life, and possibly the life of your spouse, depending on how the annuity is structured.

It's important to note that annuities can be very complex financial products, and the most basic annuities are not always what we encounter or consider. Today's investor may be more likely to encounter or explore more complex annuities, with investment, tax, and estate ramifications that add up to create a challenging, if still understandable, financial product. It's important to grasp the details of annuities before taking action.

Although individual needs are different, people who buy annuities use them to cover fixed costs, such as utilities, mortgage or rent, property taxes, and other recurring obligations, and supplement other predictable sources of income like Social Security or pensions.

When it comes to retirement and investment strategies, you have a number of choices, and there's no one-size-fits-all answer. But depending on your objectives and time horizon, any of these alternatives—or a combination thereof—might be something to consider for your retirement goals.