Life insurance was not designed to fund retirement. If your financial advisor or a life insurance salesperson has ever presented this as an option, you should proceed with caution. While an array of permanent and whole life insurance policies make it possible to withdraw cash to fund part of your retirement, there are risks involved as well as huge fees to consider.
The financial professional you're working with may not present it that way. A lot of times a salesperson will argue permanent or whole life insurance is the best way to save for retirement and avoid part of your tax bill. He or she will say whole life builds cash value you can withdraw or borrow against and tout the obvious death benefit that goes along with it. What he won't tell you is how big the commission is, and how much more you might have for retirement if you bought term life insurance and invested heavily instead.
Why life insurance shouldn't be used to fund retirement. Whole life insurance was never meant to be an investment vehicle, and it's certainly not the best way for the average family to save for their golden years. According to financial advisor Joshua Brein of Bellevue, Washington, permanent life insurance does allow your money to grow tax-free, and then you can take the money out tax-free in the form of policy loans or withdrawals, but that benefit may come at a cost. Many whole life policies come with large fees that are often loaded into the first 10 years of the policy. "This means that if anything happens over the first 10 years that would prevent you from being able to continue to pay your premiums, you're now out all the money that you have stashed away in the form of premiums, either in a policy lapse or where the policy will eat up all of your cash value just to keep itself alive," Brein says.
In addition to huge upfront fees, whole life insurance comes with higher premiums, too. Andrew McFadden, a financial advisor in Fresno, California, says the added expense of whole life insurance might even prevent families from buying enough coverage for their needs. A life insurance salesman starts by telling them whole life is better, so they purchase a policy without giving much thought to the actual death benefit itself. "As a result, most owners of permanent life insurance are underinsured, because they were sold on the fact that whole life insurance gives you something back, whereas term life does not," McFadden says.
Further, many whole life insurance policies come with a surrender charge. Let's say you fund your policy for years only to determine it's too expensive and you no longer want to keep it up. If you want to get your hands on the cash value of your policy, you'll need to pay a fee for that. Plus, there are tax consequences for withdrawing your earnings.
How you should actually save for retirement. Despite what your salesman says, most individuals would be better off with a lower cost term life insurance policy sufficient to cover their family's needs in the event of their death. When it comes to saving for retirement, there are a slew of ways to invest that don't lock your money in an expensive insurance policy or come with ridiculous upfront fees.
For starters, you should focus on investing in and maxing out your work-sponsored 401(k) accounts. Beyond your workplace plan, you can also open and fund a traditional IRA or a Roth IRA. Of course, you'll also want to build a fully-stocked emergency fund along the way. Beyond those goals, you can also open a brokerage account if you're savvy about investing and ongoing costs.
Buying a term life insurance policy and pouring the rest of your efforts into a smart and comprehensive retirement savings plan is a much smarter way to cover your family in the event of your death and save for retirement. However, there's a very specific set of criteria that might make whole life insurance work for you.
When whole life insurance makes sense. There are a few instances where a whole life insurance policy can help with retirement. "If you are in the highest tax bracket and you have fully funded all of the available tax-advantaged retirement accounts, you might be a candidate for low-cost permanent life insurance," says Taylor Schulte, a San Diego financial planner and CEO of Define Financial.
If having life insurance until the day you die is a goal regardless of cost, then permanent life insurance might also be a good idea. "Permanent life insurance can also be a good fit as a legacy enhancement strategy where required minimum distributions from an IRA are diverted into premiums for a cash value or permanent life insurance policy, thus providing a sometimes large additional death benefit to your retirement or legacy planning," Brein says.
However, if you don't fall into one of those categories, most advisors would strongly suggest you think long and hard before relying on life insurance as part of your retirement savings strategy. And when in doubt, you should hire a fee-only financial advisor for help.
Jeff Rose is a certified financial planner, U.S. combat veteran and the founder of GoodFinancialCents.com.
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