Creating Tax-Free Income Using Life Insurance: A Case Study

How Can Life Insurance Create Tax-Free Retirement Income?

Life insurance isn’t usually the first resource people think about when planning for retirement. Usually, that’s because it’s not at the top of most financial advisors lists for their clients. And while I’m not here to tell you to forget everything your advisor has said about planning for retirement, I do want you to understand how life insurance should be considered as part of your portfolio as a resource for creating tax-free income.

Understanding How Life Insurance Works

When it comes to life insurance, it’s important to understand that no matter what kind of policy you have, the death benefit is tax-free. That means that if you pass away, any death benefit your family receives will be tax free which will help your family have continued income long after you’re gone.

But, more importantly, you need to understand how permanent life insurance, such as whole life or universal life works. It includes an “investment” component known as cash value. Over time, as you pay your premiums, the cash value of your policy grows, often at a guaranteed rate, which can become a significant asset.

How Life Insurance Creates Tax-Free Income

One of the most significant advantages of the cash value in a life insurance policy is the ability to borrow against it. You can take out loans against your policy’s cash value tax-free. This is because the IRS does not consider these loans as income. It’s crucial, however, to manage these loans carefully to avoid diminishing your death benefit or surrendering your policy inadvertently. To help drive this point home, here’s a recent case study of one of our clients:

John Doe – Male, Age 56, Preferred Non-Smoker Rating
Life Insurance Amount: $414,000
Annual Premium: $25,000, paid only until age 65
Cash Values:
Year 5: $120,890
Year 10: $298,968
Age 65: $691,405
Projected Loan Amount: $40,000/year, tax-free, from age 66-100

How Is This Possible?

By taking advantage of overfunding his universal life insurance policy, our client is able to generate a significant amount of cash value in his policy in a short amount of time. This allows him to only pay for his insurance until the typical retirement age of 65. Starting immediately at age 66, he will be able to take loans from his policy for almost $40,000 every year until he turns 100 without having to pay back his loans or pay tax on those loans.

It’s important to note that these types of policies have to be structured and managed in a way that will allow for this type of performance. If done incorrectly, it can leave the client with a taxable situation. Every individual’s case should be treated uniquely to make sure that it meets the clients needs and expectations.

If you’d like to learn more about how life insurance can be used for create tax-free income for you in your retirement, feel free to reach out to us here!