Qualified plans certainly have a lot of value, but they certainly have their limitations. Permanent life insurance cash value can be a fantastic supplement to a qualified plan for retirement. A qualified plan such as a 401k is loaded with limitations and penalties imposed by the government. For example, money inside the plan is not accessible until 59 and a half without a penalty. Once a person, hits 59 and a half there are limitations with how much can be taken out. On top of that, the government determines the tax rate that you will pay when the money is taken out of the plan at retirement. While the tax rate might be one thing today, it could certainly change and be higher when you retire. The whole concept of compound interest is great, but it also builds compound tax that you must pay.
It is great if you are contributing to your qualified plan as that means that you are saving. Most americans do not have a high enough savings rate. We suggest to our clients to make sure and take advantage of any company match. If your company will match you up to 3% or 5%, try to contribute that amount and get the free money. After you reach the match, we suggest putting additional savings in things like cash value life insurance. The cash value grows tax deferred and can be access on a tax-free basis. On top of that, the government doesn’t put as many constraints on the money. There is no compound tax to be paid on the policy if you keep the policy in force. Also, life insurance cash value is liquid and you can get to it at any point. Certain types of cash value policy’s like whole life and universal life have guarantees in the cash value. You cannot lose money, like you can in the stock market. The cash value will get better no matter what.
Life insurance cash value (whole life or universal life) can be a great supplement to your retirement income. To live a healthy financial life it makes sense to diversify and build value in different vehicles. Some of the great benefits of using life insurance to supplement your retirement is that if done correctly you can withdraw the money tax free. Qualified plans are great, but they are fully taxable at retirement as you have never paid tax on them. They also have restrictions about distributions and penalties for early withdrawals. I recommend putting the amount in your qualified plan that gets you the full match. After you hit the match amount, I suggest you may want to put the money above that in a separate vehicle. Compound interest is great, but compound tax is also an issue to consider.
The way to use life insurance to supplement your retirement is to take the money out as a withdrawal up until you hit your cost basis. Withdrawing money to your cost basis, should not be taxable. Once you hit the cost basis, you should start taking the withdrawals as policy loans. If you do it this way you should be able to access the money built up tax-free. The earlier you start the policy the better as a significant amount of money can be accumulated over time. I usually suggest to my clients that they overfund the policy. In other words add cash to the policy each month above and beyond the premium level. On top of the great supplemental income and tax benefits, you should have a nice death benefit to pass along to the next generation.
