The Highs and Lows of Cash-Value Life Insurance

The Highs and Lows of Cash-Value Life Insurance

Faculty Member Michael Finke Landscape Photo
May 29, 2016

This article was originally published in InvestmentNews

Cash-value life insurance could prove to be a valuable asset for clients looking to couple an insurance need with tax and portfolio diversification in retirement. But there are some major caveats involved — namely, product considerations are complex and numerous, and using this strategy inappropriately in a retirement income plan can trigger major pitfalls for clients.

Cash-value life insurance, the most common form of permanent insurance, comes in a few flavors — whole life and categories of universal life, such as variable, indexed and current-assumption. Each has an insurance component providing a death benefit, as well as a separate, tax-advantaged cash-accumulation component earning investment interest that can be tapped during one's life.

The tax treatment is a big selling point. Investors fund the policies with premium payments, which grow tax-deferred; investors can access the principal and accumulation tax-free, if they adhere to specific guidelines, via withdrawals and policy loans. Heirs ultimately receive a tax-free death benefit.

As such, advisers say the policies can serve as a retirement-income supplement if clients (typically the very affluent) have maxed out their contributions to vehicles such as 401(k)s and individual retirement accounts and want another place to park tax-advantaged money.

If advisers consider the cash value of a low-cost, long-term whole life policy as a part of a fixed-income portfolio, the policy generally will provide more income per dollar than bonds held in taxable or tax-sheltered accounts, said Michael Finke, professor of personal financial planning at Texas Tech University, who recently conducted research on cash-value life insurance in retirement.

Tax-bracket management and reduction of sequence-of-return risk are the two best ways to use cash-value policies in retirement, according to Jamie Hopkins, the Larry R. Pike chair in insurance and investments at The American College.

For example, if a client needed an additional $10,000 in a given year but would bump into a higher income-tax bracket by taking that distribution from a traditional IRA, a withdrawal from a life insurance policy could be beneficial because it wouldn't increase the client's taxable income. (Withdrawals reduce a policy's death benefit, however, so advisers would have to weigh whether pulling from a Roth account would be more advantageous.)


Similarly, advisers can use the same principle to help manage clients' monthly Medicare premiums, which rise according to specific income thresholds.

Withdrawing from a policy could also help a client defer Social Security claiming as long as possible, to age 70, to maximize benefits.

Further, if the stock market falls during the early years of their retirement, investors can withdraw from a life insurance policy rather than lock in losses by selling riskier assets in other areas of a portfolio.

“That can really help you out over the long run,” Mr. Hopkins said.

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