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Whole life insurance's tax diversification benefits

Life Insurance

With today’s ever-changing retirement landscape, many people want a portfolio of financial assets that offer different types of income tax advantages. Life insurance can play a role in that tax-benefit strategy. Of course, life insurance is first and foremost about protection — helping loved ones carry on in the event of an untimely passing.

But some types of permanent life insurance, such as whole life insurance, have tax-advantaged features that can complement retirement savings vehicles.


Life insurance benefit: Tax-deferred accumulation

Permanent life insurance builds cash value over time.

  • In the case of whole life insurance, the cash value grows at a rate guaranteed by the insurance company.
  • Other types, like variable universal life insurance, can earn returns based on the performance of investment accounts.

Additionally, some life insurance policies are eligible to receive dividends, which can add to the life insurance protection and cash value as well.1

Cash value grows on a tax-deferred basis, which means the question of taxes doesn’t come up until the value is accessed. How fast it grows depends on the premium plan involved. For instance, some whole life insurance policies can be paid up with as few as 10 premium payments and consequently build cash value relatively quickly. Of course, the premiums for such a policy are substantially larger compared with other whole life insurance policies that extend premium payments over a longer period. Some policies, for example, spread premiums over the time it would take for a policyowner to reach an age of 100. That type of pay-to-age-100 policy has smaller premiums than a 10-pay policy but builds cash value at a slower pace.

Unlike qualified retirement savings programs, such as a 401(k) or IRA that have minimum distribution requirements, a whole life policyowner can access available cash value at any time.


Life insurance benefit: Tax-advantaged access

Distributions taken from the cash or account value of a permanent life insurance policy are not subject to taxes up to the “cost basis.” That’s the amount paid into the policy through out-of-pocket premiums. It doesn’t include any of the tax-deferred investment gains or dividend additions the policy may have had.1 And interest rates on loans from insurance policies may be more favorable than those available for personal loans.

Policyowners can take distributions or borrow against their available cash or account value for any need, like paying a college bill or coming up with a down payment on a house, and there is no penalty for accessing cash value before age 59½.2

This cash value feature is where a whole life insurance policy can serve as a useful tool in an overall retirement income strategy.

Many people rely on savings built over time and typically invest in equity markets to provide income in retirement. When markets go into retreat, it can present challenges for retirees. Taking money from a retirement account following a declining year can have a negative impact on the long-term value of the account. In particular, one or two years of negative returns early on in retirement can have a significant and damaging effect on the ability to continue withdrawing the same level of income in later retirement years. Retirees can access the available cash value of a whole life insurance policy for inevitable market pullbacks, allowing time for invested funds to recover.


Social Security options

Additionally, by taking partial surrenders of the cash value of their whole life insurance policies first, retirees can possibly delay the need to begin taking Social Security payments. And Social Security benefits increase the longer one waits to receive them.

Also, income from a life insurance policy up to cost basis, taken as an income tax-free distribution or loan, is not included in the income calculation for taxes on Social Security benefits.



Of course, all the features above are ancillary to the primary purpose of life insurance: protection for loved ones. But there, too, is a financial benefit: Life insurance death benefit proceeds are generally income tax-free.

This protection, combined with accumulation and access features, makes whole life insurance a useful option as a complement to an overall savings and investment strategy and provides for additional tax diversification of income sources.

1 Dividends are not guaranteed.

2 Access to cash values through borrowing or partial surrenders will reduce the policy’s cash value and death benefit, increase the chance the policy will lapse, and may result in a tax liability if the policy terminates before the death of the insured. If the policy is a Modified Endowment Contract, policy loans and/or distributions are taxable to the extent of gain and are subject to a 10 percent tax penalty if the policyowner is under age 59½.

The information provided is not written or intended as specific tax or legal advice. Lenox Advisors, its employees and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel.