Is Life Insurance a Smart Investment After You Retire?

Any discussion about life insurance as an investment after you retire is sure to draw strong opinions on both sides of the argument. Proponents of the idea will point to the unique properties of life insurance, such as its guaranteed cash value, tax-deferred growth, tax-free death benefit, and tax-free access to the cash. Opponents will argue that life insurance can’t be a good investment because there are too many costs and the returns are minuscule. Both sides have some merit, but their arguments don’t apply equally to all financial situations. The answer really depends on what a retiree wants to accomplish. In some cases, life insurance may be the only solution, making it a smart investment.

You Want to Maximize Your Pension

If you are going to receive a pension at retirement, you will be offered a few different options for receiving it. The single-life option pays the highest monthly income, but there would be no income for your spouse if you should die. The joint-life option would pay an income to your spouse, but you would receive a reduced current monthly payout.

A pension maximization strategy using life insurance could be utilized to maximize your current pension income while providing for a lump sum benefit that can be converted to lifetime income for your spouse. For example, if your single-life pension payout at age 65 is $5,000 per month, and your joint-life option is $4,000 per month, you would choose the higher single-life option. The $1,000 monthly difference would be applied, all or in part, to a life insurance policy. The death benefit would have to be big enough to replace at least the lower payout option of $4,000 per month. Because the death benefit proceeds are received tax-free, your spouse would benefit from a higher after-tax income.

The pension maximization strategy is somewhat complex in determining whether you would be better off with the single-life or joint-life option. A number of factors need to be considered, such as you and your spouse’s age, your projected life expectancy, your health, your tax bracket, and the dollar difference between the two options. If you have health issues and can’t qualify for preferred rates, the strategy is not likely to work. It would be essential to work with a qualified life insurance professional who can perform the complex calculations.

You Want to Maximize Your Estate

If your estate exceeds $11.7 million in 2021, it could be subject to estate taxes. With estate tax rates at 40%, your heirs may need to sell off assets to pay the tax and other costs related to settling the estate. That could be especially devastating if it resulted in the forced sale of a business or a valuable asset. Life insurance is the only solution that can provide immediate capital to pay estate settlement costs. It’s best to work with an estate planning attorney who can determine the most appropriate arrangement, including creating an irrevocable life insurance trust (ILIT) to own the life insurance. An ILIT removes the value of your life insurance from the estate, so it is not included for tax purposes.

You Want to Maximize a Legacy

Life insurance can be used to maximize a financial legacy, especially if it is likely to be diminished by taxes. This strategy is often used to maximize the transfer of a qualified retirement plan at death. For example, say you have an IRA with a balance of $500,000, and you have sufficient other assets and income to cover needs. You are considering passing the IRA on to your children; however, when you turn age 72, you will need to start making required minimum distributions (RMD) regardless of whether you need them. That will reduce the asset’s value, and the fact that you have to pay taxes on the distribution diminishes its value even further. In addition, when the children receive the IRA, they will be required to pay income taxes on distributions.

If the IRA is a legacy asset, you could turn it into a tax-advantaged legacy by taking distributions currently and using them to purchase a life insurance policy. You would have to pay taxes on the distribution, but when used to pay the premium on the life insurance policy, they would substantially increase the value of your legacy. At your death, your children would receive the income-tax-free death benefit and the remaining balance of the IRA. Everybody wins with this strategy.

You Need to Equalize the Estate for Your Heirs

In some situations, life insurance can be used to equalize the distribution of an estate. Say you have a business with only one of your children is involved and willing to continue it after your death. Your other child has no interest in the business. You or your business can purchase a life insurance policy to provide the second child with a distribution equal to the first child’s ownership interest in the business. An estate equalization strategy makes everyone happy while ensuring the business remains in the family.