Traditional retirement accounts like Roth IRAs are usually the best vehicles to save for retirement. Using a life insurance policy as an investment tool isn’t as effective as an IRA because it’s expensive and comes with more risk.
But if you’re a high-net-worth individual who has maximized your contributions to traditional retirement accounts, and have income to spare, a permanent life insurance policy with a cash value account could be a good way to supplement your retirement plan.
Life insurance vs. Roth IRA
Many people save for retirement using employer-sponsored plans, like 401(k)s. But if you don’t have an employer-sponsored plan or want to supplement one, you can get life insurance or a Roth IRA, though an IRA will be a better fit for most people.
Using life insurance to save for retirement is known as having a life insurance retirement plan (LIRP). This type of plan uses a permanent life insurance policy’s cash value component to help fund retirement.
An IRA is a retirement savings plan that you open and fund on your own. It’s one of the simplest ways to save for retirement.
Both LIRPs and IRAs are individually funded (with no involvement from your employer), so deciding between the two makes sense. But in most cases, an IRA is the best first choice between the two.
A LIRP will benefit you if you already have an IRA and have been consistently reaching your annual contribution limit.
How is a 401(k) different from an IRA?
The main difference between an IRA and a 401(k) plan is whether your employer is involved. An IRA is only available to individuals, similar to permanent life insurance, while 401(k)s are employer-sponsored and often offer some sort of employer matching.
401(k)s allow higher yearly pre-tax contributions than IRAs, but have fewer investment options. If your employer offers a 401(k), you should utilize this benefit. But you should also consider supplementing your 401(k) with an IRA and possibly a permanent life insurance policy.
See how life insurance compares with a 401(k) and Roth IRA below:
Tax comparison: LIRPs vs. traditional 401(k)s vs. Roth IRAs
Policy details | LIRP (cash value life insurance) | Traditional 401(k) | Roth IRA |
|---|---|---|---|
Contribution limits | Varies by insurer | $22,500 (+$7,500 if older than 50) | $6,500 ($7,500 if older than 50) |
How you contribute | Premiums (after-tax dollars) | Pre-tax income | After-tax dollars with no tax deductions |
How your money grows | Tax-deferred | Tax-deferred | Tax-free |
(Penalty-free) withdrawal qualifications | In most cases, none* | 59½ years old and up | 59½ years old and up, and an account at least five years old |
Withdrawal taxes | Only if your withdrawal exceeds cash value base amount | Taxed as regular income | No income taxes |
Required minimum distributions | Varies by policy premiums | 73 years old and up | None |
Income tax | Yes | Yes | No |
*A LIRP that has been overfunded, or exceeded federal tax law limits, will become a modified endowment contract (MEC), at which point you’ll pay taxes on withdrawals unless you’re 59 ½ years old and up, and your account is at least 15 years old.
How can permanent life insurance be used for retirement?
A cash value life insurance policy can supplement other retirement savings accounts, but we don’t recommend using life insurance as your main savings vehicle.
However, if you’ve reached the contribution limits for your 401(k) and IRA, here’s how putting money into your permanent policy’s cash value can be beneficial:
1. Pay extra premiums to fund your cash value
Overpaying your permanent life policy’s premiums means the extra money paid goes into the cash value and grows tax-deferred.
But there are some caveats: you’ll be penalized on withdrawals before age 59 ½ and if you exceed the annual premium limit (set by the IRS) your policy converts into a modified endowment contract (MEC) (which means extra taxes and penalties for withdrawals).
2. Use the cash value to supplement retirement
As a cash value life insurance policy owner, you can access the cash value in addition to your retirement accounts, allowing you to spread out retirement spending across multiple accounts.
For example, after a down year in the stock market, you can withdraw money from your policy’s cash value instead of drawing down from your IRA, which will replenish your IRA savings.
3. Long-term care support
Most life insurance policies allow for add-ons called riders, including a long-term care rider, which provides an accelerated death benefit.
These features cost more, but can be used as you age to pay for a nursing home or other medical costs related to long-term care.
Should you use life insurance as an investment?
If you’re trying to decide between opening an IRA (Roth or traditional) or opening a life insurance policy for the purpose of retirement savings, IRAs are almost always a better choice.
A Roth IRA offers higher returns on your contributions than what you would get from a life insurance cash value account. It’s much more straightforward than permanent life insurance, which can come with costly policy surrender charges, high premiums, and savings that aren’t guaranteed.
A Roth IRA also offers flexibility — if you fully fund it one year, but the next year you face unexpected financial hardship, you can choose not to fund it, and your existing contributions will still gain interest.
With a permanent life insurance policy, you must keep paying premiums, which are often several hundred dollars per month, or you risk your policy lapsing.
If you’re unsure if cash value life insurance fits into your financial goals and plans for retirement, speaking with a financial planner or Policygenius advisor can help.
