Using Life Insurance to Generate Tax-Free Income in Retirement

However, certain types of life insurance can be used to generate additional sources of "tax-free income" during an individual's retirement years.

Will it make sense for every client sitting across from you? Definitely not! But some of them are leaving real money on the table by not knowing this exists.

Here are some of the key points to keep in mind when providing guidance to your clients.

What People Often Don't Realize About Life Insurance

Permanent life insurance policies, such as whole life or certain universal life policies, can build cash value over time in addition to providing a death benefit.

Therefore, if your client has established and funded their life insurance policy properly, they may borrow against this accumulation through policy loans without incurring income taxes on the money borrowed.

But keep in mind: evaluating whether to use a life insurance policy to create "tax-free income" requires a structured plan, consistent premium payments, and a long-term commitment. Unlike purchasing a term policy, creating a cash reserve inside a life insurance policy cannot be done overnight. 

Tax-Free Income Created Within a Life Insurance Policy

Here is a simplified example of how tax-free income created within a life insurance policy works:

1. Your client invests funds into a properly structured permanent life insurance policy over time.
2. As your client continues to make payments, the policy's cash value accumulates.
3. In retirement, your client may access that cash value through policy loans.
4. Because policy loans are not treated as taxable income under current tax law, this strategy provides your client with tax-advantaged retirement income.

This income can help your clients supplement their Social Security, reduce their need to withdraw from taxable retirement accounts, manage tax brackets in retirement, and provide flexibility if the market drops.

And if the policy is set up right, any remaining death benefit passes to their beneficiaries without income tax.

Here's the trade-off: taking policy loans reduces the death benefit and requires careful management. Not funding the policy well, borrowing too much, or letting it lapse can lead to unexpected taxes.

Why Some Retirees Consider This Strategy

Life insurance-based income planning is often considered by individuals who have already maxed out their retirement accounts, have a longer time horizon (10+ years before income is needed), or are concerned about future tax rates. 

This approach can be especially appealing to higher earners who want more tax-efficient or tax-diversified planning options beyond 401(k)s and IRAs.

When It May Not Make Sense

This strategy doesn't work for everyone.

It may not be appropriate if your client has limited cash flow or needs short-term liquidity. Or perhaps they're only looking for low-cost life insurance coverage.

Using life insurance for income planning is a long-term approach that works best when carefully planned and integrated into a larger financial strategy.

Important Considerations

Before exploring this option, it’s important to know the policy type, how it will be funded, how it’s set up, and how it will be reviewed and updated over time.

Not every life insurance policy is meant to provide income. In fact, many aren't designed that way at all.

And while policy loans usually aren't taxed, they aren't “free money.” If the policy ends with unpaid loans, taxes might be owed.

Tax Diversification

A major risk for retirees is not knowing what their future tax obligations will be. 

Many retirees keep most of their savings in tax-deferred accounts like traditional IRAs and 401(k)s, but withdrawals from these accounts are taxed as regular income.

Having a possible tax-free income source can give retirees more flexibility:

• Take taxable income when rates are low
• Use tax-free income when rates are high
• Manage Medicare premiums
• Control required minimum distributions
• Avoid being pushed into higher tax brackets

How Core Income Can Help

If you want to see if this approach fits your clients' retirement plans, start by looking at their full financial situation... How tax-diversified is their retirement plan? What does their projected retirement income look like? Do they have legacy goals? Have they maximized other retirement vehicles?

Let's evaluate whether a life insurance-based income strategy makes sense for your clients. We'll go over the benefits, the drawbacks, and how it stacks up against other options your clients are likely already using. 

Call us anytime at 800-541-7713 or email us at info@coreincome.com to get started.

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Core Income is an FMO, IMO, and independent insurance brokerage dedicated to serving financial advisors, their staff, and their clients.

Our mission is to help advisors deliver financial certainty by supporting them through actuarial precision, elite responsiveness, and collaborative partnerships.

To learn more about how we can support you, schedule a conversation with our team or call us at 800.541.7713.

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