U.S. Markets closed

Is Life Insurance a Retirement Investment?

Roger Wohlner

Sometimes it seems the insurance industry believes that buying a life insurance policy in one form or another is a cure for any financial ill. To be clear, life insurance is a part of many properly constructed financial plans. Many of us need to provide this protection for our families in the event of an untimely death. Parents, and anyone who provides support for someone else, might consider life insurance protection.

Life insurance can also be used for estate planning purposes or as a vehicle to ensure that a business can continue to operate in the event of the death of an owner or key employee.

My beef, however, is with life insurance marketed as an investment, most often as a retirement investment vehicle. To say the life insurance folks are inventive and creative marketers is an understatement.

A typical scenario.

Life insurance is often marketed to high-earning professionals and business owners as a means to put away additional funds for retirement over and above any type of retirement plan they might already have, such as a 401(k).

The pitch is this: buy a policy with underlying investment vehicles that will build cash value over time. The client funds the policy for certain number of years and the growth in the cash value will eventually negate the need for additional premiums. At retirement the client can withdraw cash as a tax-free loan for retirement. The loans never need to be repaid and the only consequence is a reduced death benefit.

What could go wrong?

While the above scenario can work, it is far from the "slam dunk" opportunity portrayed by some agents and other financial salespeople. Among the things that could derail this strategy:

--The investments don't perform as well as assumed in sales illustrations.

--The policyholder can't fund the policy to the level anticipated.

--The policyholder withdraws too much cash from the policy and triggers a taxable event.

Additionally, investing under a life insurance wrapper can be terribly expensive and there are generally surrender charges written into such policies that can make it very expensive to get out of a policy early or convert it to another saving or investment vehicle, often for a number of years.

Consider alternatives.

If you are pitched a plan to use life insurance as a retirement investment make sure that you have reviewed and exhausted all other alternatives first, including:

--Fully funding a qualified retirement plan including a 401(k) or SEP-IRA.

--Starting a pension plan for yourself. This includes a cash balance plan.

--Funding a low-cost, no-load variable annuity.

Even if you find that this life insurance strategy is the best course of action make sure that you shop policies and companies. You will want to look at the quality of the underlying investment and understand all underlying fees and expenses.

If you buy a policy, make sure that you continue to monitor it. Set aside money to fund it, watch the performance of its underlying investments, and be sure withdrawals won't a trigger a tax penalty?

Life insurance can help provide financial security for your family. However, if you buy it for any reason other than the death benefit, make sure that the policy fills the alternative role in the best possible fashion before writing your first premium check.

Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides financial planning and investment advice to individual clients, 401(k) plan sponsors and participants, foundations, and endowments. Roger is active on both Twitter (@rwohlner) and LinkedIn. Check out Roger's popular blog The Chicago Financial Planner where he writes about issues concerning financial planning, investments, and retirement plans.

More From US News & World Report