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Generating income during retirement is challenging. Fortunately, your life insurance policy can be a valuable source of funds to cover retirement expenses.
Read on to learn more about how you can use your life insurance for retirement income.
The Income Dilemma
Retirement planning is an essential aspect of financial planning. If you’re like most retirees, you rely on your investment portfolio to provide a substantial portion of your monthly income.
In addition to investments, retirees often rely on a pension and Social Security to cover the cost of retirement. Unfortunately, those three income sources aren’t always enough.
During retirement, it is prudent to financially prepare for unexpected expenses. Medical bills are the leading cause of bankruptcy in America, and the disturbing thing is that over half of those who are forced to file for bankruptcy have health insurance. Where will you come up with the money to pay the doctor if your health insurance is denied?
You may be able to cover income shortfalls by using your life insurance for retirement income. We’ll explain how to cash in on your life insurance policy later in this article.
Generating income from an investment portfolio is ideal. But, it does come with a major dilemma – investments are subject to risk.
Stocks go up and down. Bonds pay a steadier rate of income.
But bond prices fall when interest rates rise, reducing the amount of principal in your portfolio.
Even a well-diversified portfolio can suffer substantial losses when markets trend downwards. Those losses jeopardize your chances for a secure retirement. You must factor this possibility into your long-term retirement plan. Choose investment options that have shown they can weather the storms of time.
The 4% Withdrawal Rule
Financial advisers used to counsel clients to limit annual withdrawals to 4% of total IRA and retirement savings. For example, if you have $1 million in savings, you could “safely” withdraw $40,000 a year. They advised that doing so would make the money last for at least 30 years.
Now, CNBC reports that 4% is too large a withdrawal in today’s low-interest rate environment.
A more realistic rate of withdrawal now stands at 2.75 – 3% for the average retiree. Many retirees are therefore left to search for other sources of funds that they can draw from to make ends meet. Some of them are forced to go back to work, while others have to downscale their standards of living.
Do you have enough savings to live off of 3% annually? Most Americans don’t. According to one report, the “estimated median savings for sixty-somethings is $172,000.” That equates to $5,160 annually at a 3% withdrawal rate, which is well below the poverty line.
After you factor in Social Security (which currently averages $1,413 a month), you’re left with $22,116 a year. This may sound sufficient, but when you consider that healthcare costs during retirement are extremely high, that amount seems significantly smaller.
Accessing Your Life Insurance Cash Value
A permanent life insurance policy that has accumulated a material amount of cash value could give you at least one source of funds to draw from.
There are several different ways to do this; the best way for you will depend upon your needs and circumstances.
Cancel the Policy
If you no longer want or need the death benefit coverage from your cash value life insurance policy, you could cancel it. The insurance company will then send you a check for the amount of cash value that is left after all applicable surrender charges and fees are assessed.
If the amount you receive is in excess of the total amount of premiums that you paid into the policy, you will be taxed on the difference at your top marginal tax rate.
One advantage that this provides is that it will continue to lower your expenses on an ongoing basis as you will no longer have to make the premium payments. However, this will leave your beneficiaries bereft of the death benefit that they would have received.
It is possible to withdraw the accumulated cash value in the policy without canceling the coverage.
Be aware that the death benefit will be reduced by the amount of the withdrawal and that you will still have to pay the policy premiums going forward.
Again, if the amount of cash value that you withdraw exceeds the total amount of premiums that you have paid into the contract, then the difference will be taxed as ordinary income.
You can take out a loan from your policy using the cash value in the policy as collateral. The loan will charge you a predetermined rate of interest and if you take out too much money, the policy can lapse.
Many policyholders prefer this option because there are no underwriting requirements for this type of loan. The borrower is essentially borrowing from him or herself.
In many cases, the loan does not have to be repaid, although the policy’s face value will be reduced by the amount of any outstanding unpaid loans.
Both direct withdrawals and policy loans can be exercised as needed without taking the entire cash value in one go.
Many people use life insurance as a form of supplemental income during their retirement years. A cash value insurance policy can be an excellent resource to draw from if all you need is a boost in your monthly income. This is true regardless of what type of permanent life insurance product you have.
It could be a whole life insurance policy, a universal life insurance policy or a variable universal life insurance policy. But note that term life insurance cannot be used in this manner because it has no cash value component.
The Life Settlement Solution
Using the cash value in your life policy for current income is fine under normal circumstances. But, as mentioned previously, what if you are diagnosed with something not covered by Medicare or health insurance? You may need access to more money than you have in your policy’s cash value in a very short period of time.
Fortunately, you may have an alternative, known as a life settlement.
Instead of cashing in your policy or taking out a loan, you simply sell your policy to a qualified buyer who will leave you as the insured on the policy and name itself as the new beneficiary. The buyer will then assume the responsibility of paying the policy’s premiums from that point forward.
The buyer will then collect the death benefit upon the death of the insured, and the seller (you) will be paid a substantial amount of money up front by cashing out life insurance before death. Sometimes, the policy seller receives the payment in as little as a week. In many cases, this can be at least two to three times the entire amount of cash value in the policy.
If you are terminally ill, a viatical settlement may be the way to go. This arrangement is similar to a life settlement, where a buyer, known as the viator, purchases your life insurance policy and names itself the beneficiary. You collect a hefty sum up front and remain as the insured on the policy.
The biggest advantage of using a viatical settlement over a life settlement is that the payout on the former type of transaction is usually larger. The main caveat in a viatical settlement is that the policyholder must have a low life expectanc y.
Using Life Insurance for Retirement Income: The Bottom Line
Life insurance can be an important source of supplemental income on both a monthly and a lump-sum basis when you retire. Consult your financial advisor or life insurance agent for more information on how you can best access the cash value in your life insurance policy.