Does your retirement budget account for taxes? If not, your money might not go as far as you think it will. Taxes can be owed at multiple points – when you earn money, when it grows interest or even when you withdraw it.
If you use a regular 401(k) for your retirement savings, for example, you’re contributing money pre-tax. This sounds like a good deal, and it provides a great incentive to invest more – but the tax-free situation doesn’t last forever. When you take distributions during retirement, you’ll have to pay taxes.
Even your Social Security benefits may be taxed. Depending on how much income you make, up to 85 percent of your Social Security benefits can be subject to federal taxes. On top of that, some states also tax Social Security.
All these taxes add up, and the result is a much smaller nest egg than you’d been counting on.
There is good news, though. Some retirement savings options have tax advantages that let you keep a bigger chunk of your savings. You might be surprised to learn that one of these savings vehicles is life insurance.
That’s right. Life insurance does more than provide a payout if an unexpected death occurs. The right policy can also act as a tax-advantaged retirement savings tool.
A Life Insurance Policy for Every Need
Life insurance policies come in different varieties to suit different needs. Term life insurance policies last for only a set period of time, possibly 10 years or 20 years, for example. These policies are generally purchased for the death benefit, the payout that occurs if the policyholder dies during the term of the policy.
Universal life insurance also provides a death benefit, but unlike term life insurance, it does not have a set expiration date, and it builds a cash value over time. Many policies also offer living benefit riders allowing you to use a portion of your death benefit while you’re still living, to cover costs associated with terminal illness or long-term care expenses.
Universal life insurance also comes in multiple varieties. With fixed universal life insurance, the value of your investment is set. With variable life insurance, investment growth is tied to market performance, resulting in great potential but also great risk. Indexed universal life insurance occupies a middle position. With this product, you get a potential for growth, but you also have protection against a market downturn.
With indexed universal life insurance, you can increase your investment by paying more than the cost of insurance. This increases the cash value, which can be tapped for any purpose. This money does not need to be paid back. Instead, the amount that you withdraw is subtracted from the death benefit.
The Tax Advantages of Life Insurance
This cash value is what makes universal life insurance work as a retirement savings tool. The tax advantages are what make it appealing.
When your money grows in an indexed universal life insurance policy, the growth is tax-deferred. When you withdraw money from your policy, these payments can be tax-free. And remember – the cash value can be tapped for any reason, and it does not have to be paid back.
This is how an indexed universal life insurance policy produces tax-free retirement income.
Are you interested in tax-free retirement income? To see if life insurance is right for you, download our Financial Planning Needs Analysis.