Life Insurance as a Retirement Plan: Smart Strategy or Bad Investment?

Although it’s possible to use permanent life insurance to save for retirement, it’s not the best option for most people. Here’s why.
Last updated Jun 19, 2020 | By Ben Luthi
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Life insurance can do a lot more than just protect your family in the event of your death. With permanent life insurance policies, it’s also possible to use your life insurance plan to save for the future, including retirement.

But although many agents push these types of life insurance policies heavily, they’re really only worth considering for a small percentage of people. Here’s what you need to know about life insurance retirement plans, how they work, and whether you should consider them.

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Life insurance retirement plans explained

If you buy a term life insurance policy, your life insurance beneficiary will receive a death benefit if you die during the policy’s term. Once the term expires, however, you’re no longer covered.

Permanent life insurance policies, on the other hand, remain in effect for the rest of your life and also include a cash-value component. A portion of your monthly premiums — which are often significantly higher than term policy rates — goes into this cash-value account, and the balance grows over time.

Depending on the type of permanent policy you choose, your cash-value balance may grow at a low but safe rate of return, or you may be able to take advantage of investments with a higher risk-return ratio.

The idea is that, over time, you can pay into your permanent life insurance policy and retain the protection it provides while building your retirement savings.

This approach to retirement is a long game. When I used to sell life insurance, I reviewed several projections for whole life policies, for instance, and it typically took 10 years to break even with the premiums and 20 years to yield significant enough growth to make it worth it.

Life insurance retirement plan: pros and cons

There are benefits and drawbacks to using a life insurance policy to save for retirement. Here’s what to consider before you purchase one.

Pros of using life insurance as a retirement plan

  • Tax advantages: Your cash-value account grows tax-deferred like a traditional 401(k) or individual retirement account. This means that all the money you pay into the account in the form of premiums won’t be taxed if you cancel the policy to get access to your cash. Only the growth portion of the balance will be considered taxable income.
  • Guaranteed growth: Most permanent life insurance policies offer a guaranteed minimum interest rate, which means that you don’t have to worry about your cash value dropping if the stock market declines. That said, if a life insurance agent shows you a projection of what your cash-value balance can be at a certain point in the future, that’s not necessarily guaranteed.
  • An additional option for the wealthy: If you have enough cash flow to max out your 401(k), IRA, and other tax-advantaged retirement accounts, a permanent life insurance policy can be an excellent way to continue saving in such a way to limit your exposure to income tax in retirement.

Cons of using life insurance as a retirement plan

  • It’s a costly way to invest. Whole life insurance policies cost between five and 15 times as much as term insurance policies. And if your financial situation changes down the road, you’ll risk losing the policy entirely if you can’t continue making those payments.
  • Safe isn’t always best. The idea of getting a guaranteed minimum interest rate is appealing, but life insurance policies typically won’t give you the same returns you can get in the stock market. And if you’ve still got decades before you plan to retire, you can stand to take on more risk to get a better return.
  • Projections aren’t guaranteed. When a life insurance agent shows you projections of what your cash-value account will look like 10 or 20 years in the future, you may not actually get those figures. For example, I purchased a small whole life insurance policy for my daughter when she was born, and the guaranteed cash-value balance is less than half of the projected balance after 20 years. That’s not to say you won’t get something closer to the projected balance, but it is a gamble you have to take.

When a life insurance retirement plan makes sense

In most cases, the drawbacks outweigh the benefits of purchasing a permanent life insurance policy to save for retirement. However, there are a couple of exceptions to that rule.

You’ve maxed out other retirement plans

Wealthy people who have maximized their tax savings via other retirement savings plans can benefit from adding a life insurance policy into the mix. In addition to providing tax-deferred growth, permanent policies also typically allow you to borrow from your cash-value account on a tax-free basis.

You can choose to pay back that money with interest, or you can keep it and it’ll be deducted from your death benefit when you die or surrender value when you opt to cancel the policy.

You need a permanent life insurance policy for other reasons

If you have significant health issues and a term life insurance policy, you may struggle to get a new policy when your current one expires. If you have a permanent policy, however, you don’t have to worry about losing your protection, and the cash-value component could be considered an added benefit.

Alternatives to life insurance for retirement

Even if you can afford to purchase a permanent life insurance policy, most people will benefit from buying a term policy and investing the difference between its cost and the price of a permanent policy. Investment options include:

  • 401(k): 93% of employers offer a 401(k) or a similar employer-sponsored retirement plan, according to the Society for Human Resource Management. Of those, 75% offer a matching contribution, which boosts your retirement savings rate. Make it a goal to contribute enough to maximize the employer match — it’s essentially free money.
  • Individual retirement account: Whether you have a 401(k) or similar plan, you can also save for retirement using an IRA. The only drawback is that IRAs have a relatively low annual contribution limit — it’s $6,000 for most people in 2020. Traditional IRAs offer tax-deferred growth like 401(k) accounts, and Roth IRAs allow your investments to grow tax-free.
  • Health savings account: A health savings account (HSA) is primarily designed to allow you to save for eligible medical expenses on a tax-free basis. But if you don’t use those funds now, you can hold onto them for retirement, where health care can cost hundreds of thousands of dollars.

Life insurance retirement plan FAQs

Here are some of the most common life insurance questions we came across and their answers for you.

Can I use life insurance for retirement?

Yes, it’s possible to use a life insurance policy to help fund your retirement goals. Keep in mind, though, that not all life insurance plans offer this — in particular, term insurance plans don’t. Also, terms, premiums, and growth opportunities can vary based on the type of permanent insurance policy you purchase.

If you’re thinking about using a life insurance policy for retirement, speak with a financial advisor, who can help you understand whether it’s the right fit for you and provide you with a clear path to get the best options available.

Is life insurance better than a 401(k)?

For many people, a 401(k) is the first place to start saving for retirement. That’s especially true if your employer offers a matching contribution.

For example, let’s say your employer provides a 100% match of up to 3% of your salary — you contribute 3% and your employer adds 3%. That’s an immediate 100% return on your investment and boosts your savings rate to 6% of your gross income, almost half of the recommended savings rate of 15%.

Beyond that reason, a 401(k) is typically a better option than a life insurance policy because it allows you to invest in stocks, bonds, and other securities, which can help you gain a better return over the long term.

Is life insurance better than an IRA?

You won’t get matching contributions with an IRA like you will with a 401(k) plan. But because IRAs offer tax-advantaged savings and give you the flexibility to invest in a variety of securities, it’s generally better than a life insurance policy.

The only drawback is you’re limited to how much you can save in an IRA each year. Also, the tax benefits of an IRA phase out for certain high-income taxpayers. So if you make enough that you don’t get any tax benefits from one of these accounts, a life insurance policy may be another option.

Is permanent life insurance a good idea?

For most people, permanent life insurance isn’t the right fit. It’s expensive and doesn’t provide as many benefits as traditional retirement accounts. But in some cases, permanent life insurance may be worth considering.

For example, you may consider one if you’ve maxed out all of your other retirement account contributions and you still have a significant amount of money you want to put toward retirement.

You may also think about buying one if you have health issues that could make it challenging to get approved for a term policy in the future — in fact, some of the best life insurance companies allow you to convert your term policy to a permanent one without undergoing another medical exam.

Before you choose a permanent life insurance policy, consult with a financial advisor, preferably one who doesn’t also sell life insurance to ensure you avoid making a costly retirement mistake.

The bottom line on life insurance for retirement

Using life insurance to save for retirement isn’t a crazy idea, but it’s not the best way to save for most people. As with any financial product, it’s important to consider all of your options and consult unbiased sources to ensure it’s the best decision for you.

Before you get to that point, though, make sure you’re saving as much as possible into your 401(k) or similar employer-sponsored plan, IRA and HSA.

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