Using Life Insurance in a Retirement Plan

Much like how cereal can be a part of a balanced breakfast, life insurance can be part of a balanced and holistic retirement planning strategy; however, the first challenge to overcome when considering whether life insurance can be leveraged in your clients’ planning is the public’s waning knowledge on the subject. According to research, as of 2024 only half of Americans owned any kind of life insurance at all — this follows a steady decline from 63% ownership in 2011, leaving over 100 million people with a significant life insurance gap.¹

Public perceptions on life insurance are often at odds with reality, especially among younger generations: only 36% of Gen Z individuals own life insurance, with rates generally increasing by age despite the utility of policies at any stage of life and the fact that such a gap leaves younger Americans uniquely vulnerable to life’s uncertainties. Many Americans believe life insurance is too expensive for them to afford, though nearly three-quarters of them overestimate its cost significantly; additionally, the number of different life insurance products (term life, whole life, universal life, etc.) are often confusing enough to make people avoid the subject.¹

With retirement planning growing more complex and do-it-yourself each year, your clients considering retirement need all the income sources they can get. But should life insurance be one of those solutions? And how can financial professionals properly leverage it?

Why is Life Insurance Important?

On paper, life insurance is often simplistically understood as a death benefit: one or more individuals receiving compensation in the form of money upon the passing of another person to pay for expenses, supplement surviving loved ones, and other needs. However, retirement planning experts are highlighting the key role life insurance policies can play for advisors and clients alike — even when the policyholder/insured is still alive.

Much of this strategy has to do with leveraging cash value life insurance: a form of life insurance that policy holders pay cash into over time to build value, much like a 401(k) or IRA — and which they can later make withdrawals from largely tax-free. Such policies often have higher premiums for holders, and it’s true that taking out too much cash can eventually deplete death benefits, but experts say with proper management, clients really can have their cake and eat it, too. This is especially important when considering the possibility of a serious medical issue in old age and the expenses that come with it.

“The idea that you need to ‘lose to win’ with life insurance simply misses the many advantages of modern life insurance policies,” said College Professor of Practice Steve Parrish, JD, RICP®, CLU®, ChFC®, AEP®. “In some ways, these policies can do not just double duty, but triple duty for the retiree. If using a cash value policy with a long-term care (LTC) or chronic illness rider, that contract can provide tax-free retirement income for the healthy retiree, be a source of needed income for the retiree who incurs a long-term care event, and still ultimately pay out a tax-free death benefit to heirs.”

Paul Wetmore, MBA, LUTCF®, CLU®, FSCP®, an adjunct professor of insurance at The College, concurred with Parrish that using life insurance can actually reduce strain on a client’s other retirement planning assets and allow them to perform better over time.

“For example, a client without the hybrid life/LTC policy may need to have more assets earmarked for an unexpected need and be required to keep them set aside in something underperforming — maybe not in cash, but something low-risk and very liquid,” he said. “The lost performance on those assets may have a larger negative impact on retirement income when compared to the plan that has some current cash flow through life insurance.”

Life Insurance As a Retirement Plan

While many financial advisors may focus on planning for higher-income or affluent clients, experts emphasize that using life insurance in retirement planning isn’t just a strategy for that sought-after group, but one that can be applied to nearly any retirement plan. In fact, there’s even a term for it: Life Insurance Retirement Plan, or LIRP for short.

Despite popular perception, it’s often good to encourage clients to buy life insurance young so they can continue to pay into it as they age. That said, even with clients already in retirement, life insurance can still be a valuable investment. For those who may have maxed out their other savings vehicles like IRAs and 401(k)s, those who have dependents or a spouse relying on their financial support, or those who want to leave a legacy while still enjoying retirement, life insurance can be a valuable part of the retirement plan toolbox.²

In particular, married couples in which one partner is the primary source of income or caregiving or people who want to leave a legacy after they die can make strong use of life insurance as a retirement asset.

“In the first case, if one of those partners dies shortly after retirement, the surviving spouse may need life insurance either to replace the lost income of the deceased spouse or to pay for the costs of caregiving that that spouse was providing,” Parrish said. “In the second, tax-free life insurance is far more efficient as a legacy vehicle than leaving IRAs, 401(k)s, and other taxable accounts. Also, cash value life insurance can be a useful tool for securing a tax-favored source of retirement income that can help supplement other sources of retirement income and bridge Social Security.”

Wetmore agreed, but also notes that life insurance solutions may still differ subtly depending on the economic status of the client.

“Very wealthy clients may be more focused on strategic income tax-planning strategies rather than the long-term care benefits, as many high net worth clients are prepared to fund their likely health care from their assets instead of LTC insurance,” he said. “The vast ‘mass affluent’ population, though, will likely want to avoid significant asset depletion from a long-term care need through the hybrid policy benefits.”

In the end, using life insurance policies to fund a retirement plan should be considered in the context of clients’ unique goals — but especially in the context of tax planning, Parrish says it can be the ultimate flexible support option.

“Life insurance is a far more tax-efficient means of transferring wealth at death than 401(k)s or IRAs,” he said. “Keep in mind that more likely than not, the retiree’s children will be inheriting their parents’ wealth when the children are in their peak earning years and potentially in a high tax bracket. Also, research has shown that when retirees leave a known legacy rather than just leaving whatever is left over, they are happier in retirement. They can use life insurance for the legacy, and not feel guilty about spending their other retirement savings.”

More on Life Insurance and Retirement Planning

• Subscribe to Knowledge Hub+ today to view this session on using life insurance in retirement planning
• Specialize in insurance planning with the Chartered Life Underwriter® (CLU®) designation
• Enhance your retirement planning knowledge with the Retirement Income Certified Professional® (RICP®) designation
• Read our ultimate guide to choosing a life insurance policy