The Top 4 Benefits of Using Life Insurance in Retirement Planning

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Article by David A. Littell and C.W. Copeland

Getting clients focused directly on their need for life insurance is often difficult. Life insurance sales are often tied to discussions of other financial goals, like selling a business through a buy-sell agreement or as a source of funding for estate taxes. With many clients focusing on retirement planning today, life insurance can be an important part of the retirement planning puzzle as well. Here are a number of different ways to use life insurance in retirement planning.

1. Saving for Retirement

Saving on a Tax-Advantaged Basis: Because of the flexibility and tax advantages of life insurance, cash value life insurance policies can be a vehicle for saving for retirement—especially for those who have maxed out contributions to tax-deductible plans (e.g., 401(k) and IRA) and tax-exempt plans (e.g., Roth IRA). Earnings in a life insurance policy grow tax deferred, and as long as the policy is not a modified endowment contract (MEC), the cost basis can be withdrawn first. Policy loans in a non-MEC policy do not trigger tax either. So withdrawals, loans and even partial surrenders (as long as they do not exceed the cost basis) are tax-free. And as long as the policy remains in force at the death of the owner, death proceeds go to the beneficiary income tax-free.

Product Design: When designing a life insurance policy in part to meet retirement savings objectives, there is a lot of flexibility. First, the policy can meet a number of investment objectives. Traditional policies (whole life and universal life) provide returns guaranteed by the carrier. The returns, although fixed, tend to be higher than CD rates and sometimes comparable to fixed income securities. Variable products, on the other hand, don’t have guarantees and policyholders choose investment alternatives. This is not necessarily a bad outcome because in a good market, the policyholder can achieve gains in excess of what the company would have consented to in a traditional policy. Second, some policies (universal life and variable universal life) offer both flexibility of premium and adjustable death benefits, allowing flexibility in the amount contributed. Third, in designing the right policy, the policy can be designed to meet a range of client objectives. If the client is more concerned about saving for retirement than the death benefit, for example, the death benefit can be minimized to lower the cost of insurance. When designing a policy like this, care should be taken to ensure meeting the regulatory definition of life insurance and to ensure that the policy is not treated as a MEC. Finally, these types of policies can be purchased by individuals or provided through a company-sponsored Sec. 162 plan, and the employer can fund some or all of the premium dollars.

2. Replacing Income

Replacing Lost Social Security Benefits: Income replacement, a traditional reason for purchasing life insurance, has a place in retirement planning as well. When a couple retires (at age 62 or later), Social Security benefits are generally paid to both spouses, either worker’s benefits to both or one worker’s benefit and a spousal benefit if one spouse had not worked or has limited income. After the first spouse dies, the remaining spouse continues to receive the higher of the two benefits. This means a reduction in monthly income that can be one-third with a spousal benefit (and both began benefits at full retirement age) or up to half if both had equivalent worker’s benefits. After evaluating the income needs of a surviving spouse and looking at available sources of income, life insurance to replace the loss of income may be appropriate. This might be an appropriate application for a first-to-die joint policy, since the need is income replacement for the remainder of the single spouse’s life. 

Guaranteeing Income: There is another aspect to providing income for a surviving spouse. When the assumption is that the retirement income needs of the surviving spouse will be self-insured—that is, supported with the remaining portfolio balance—the couple is required to spend more conservatively in order to ensure that sufficient assets will remain. Having a life insurance policy allows for a higher spending rate while both spouses are alive, as the death benefit guarantees the assets to fund the remaining retirement income need. 

Maximizing Pension Benefits: When retirees are eligible for a monthly benefit from a defined- benefit plan, they will generally have the option to elect a single life annuity that pays only for the length of the participant’s life or a joint and survivor annuity that pays a reduced benefit at retirement (due to the longer payment period) and continues to pay a benefit to the participant’s surviving spouse. An alternative to electing the joint and survivor annuity is to elect the life annuity and buy life insurance. One issue is whether the amount of life insurance purchased meets the survivor’s income needs. However, another key issue is the probability that a survivor benefit will be paid at all. For example, it’s much harder to elect the joint and survivor annuity if the retiring plan participant is a 65-year-old woman and her husband is age 70. In this case, life insurance seems like a much more flexible solution, as in this case a death benefit will always be paid—either to the spouse or to other heirs.

Protection: When working with younger couples, life insurance is also part of the retirement planning conversation, as nothing can undermine a retirement plan more than an early death. Not only does income need to be replaced to make up for lost income or services (for a stay-at-home parent) after the death, but there also has to be consideration of the loss of retirement contributions and other employer-provided benefits.

3. Long-Term Care Benefits

For the retiree who either has no long-term care insurance or has only a modest policy in force, another option is a “combination” policy that allows a consumer to have two forms of insurance protection in one policy. The “life” portion of the policy pays a death benefit, and the “long-term care” portion can be paid from assets designed for the death benefit. The approach to achieving these two goals varies from carrier to carrier. Some offer an “optional rider” where an ongoing premium is paid, while others offer “multiples” of long-term care benefit options where the owner chooses the amount of death benefit applied to long-term care.

One advantage of this approach is that meeting the medical underwriting requirements for the “combination” policies may not be as difficult as with long-term care insurance. A medical exam is required in some cases, but most policies are offered using “simplified underwriting.” This approach is not appropriate for those who do not have a life insurance need or cannot afford the premium (most are sold as single premium policies, which can require premiums of $50,000 or more). But for some retirees looking to use the same premium dollars to meet multiple needs, a policy like this can offer the ability to partially fund a long-term care need or provide a guaranteed death benefit to heirs if long-term care is not needed. This type of policy also offers the flexibility to access cash value to meet other retirement income needs as well, if that becomes necessary.

4. Guaranteeing a Legacy

Enjoy Retirement: There are clearly those retirees who spend too much, but there are also those afraid to spend at all. One common reason for concern about spending too much is the desire to leave a legacy to family members. When this is the case, guaranteeing a legacy through the purchase of life insurance can free up retirees to enjoy their retirement more—possibly even providing more for their families both during their lifetimes and after death.

Leveraging the Legacy: In addition, for retirees with extra funds that they would like to leave to children, grandchildren or even a charity, the amount gifted can be leveraged by purchasing life insurance. Of course the amount of death benefit depends on the individual’s age and health. Cash value life insurance also allows the retiree to retain flexibility, so that funds are still available to meet retirement needs or, as discussed above, even be available in the event of a long-term care need.


David A. Littell, JD, ChFC®, CFP® is the director of the New York Life Center for Retirement Income, a Professor of Taxation and the Joseph E. Boettner Chair in Research at The American College. He speaks regularly to financial advisors and benefits professionals on pensions, retirement planning, and working with older clients. Professor Littell has also co-authored several books associated with American College courses: Planning for Retirement Needs, Financial Decision Making at Retirement, and The Practitioner’s Guide to Advanced Pension Topics. C. W. Copeland, Ph.D. is an Assistant Professor of Insurance at The American College of Financial Services. Dr. Copeland conducts scholarly research in Behavioral Economics and teaches graduate-level business courses. He has been a regular guest on radio and television shows across the country where he addresses audiences on financial planning strategies on a regular basis. Dr. Copeland has more than 16 years of industry experience as a financial planner. He holds numerous licenses and registrations in the areas of investments and insurance.

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