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Once the kids move out and the house is paid off, it may seem like you don’t really have a need for life insurance anymore—after all, some of the main things you would want a death benefit for are now behind you (phew!). But as you approach retirement, life insurance—specifically permanent life insurance—can still fulfill many different roles in your financial plan.

How to use permanent life insurance in your retirement planning

With its guaranteed death benefit that won’t expire and tax-advantaged cash value that you can access at any time for any reason, permanent life insurance can help you with a number of major financial goals in retirement. Here’s how to use permanent life insurance in retirement.

Using life insurance to weather down markets in retirement

Market-based investments are an important part of a retirement plan because they help you grow your wealth and can protect you from inflation over time. If prices rise, typically your investments will also increase in value. But market declines are also a reality of investing. If you’re forced to sell investments to continue to create income when the market falls, you may end up taking a larger chunk out of your retirement nest egg than you want.

That’s where permanent life insurance can play a major role in your retirement planning. With whole life insurance (one of the types of permanent life insurance), your cash value is guaranteed never to go down. Since it’s not tied to the market, it can allow you to hang onto those market-based investments when the markets fall. Instead, you could either take cash value out of your policy (which will permanently reduce the death benefit) or simply borrow against it (which will temporarily reduce the death benefit until you pay back the loan once your investments regain value). 

Using life insurance for tax efficiency in retirement

Because of our progressive tax system, the more you earn in a given year, the larger the percentage of your additional earnings you will have to send to the IRS. This remains the case during retirement, because when you withdraw from your traditional 401(k) or IRA, you’ll owe income tax on those funds.

Let’s say you have higher-than-expected costs in a given year in retirement—like an added expense you didn’t anticipate—and you have to withdraw more from your retirement accounts to cover them. The larger withdrawals may put you into a higher tax bracket, and when that happens, you’ll have to withdraw more money to also cover the increased tax liability.

For that reason, it’s helpful to have a mix of taxable and non-taxable sources that you can pull from in retirement. With permanent life insurance, you can withdraw the basis that you pay into the policy tax-free. After that, you can borrow against your cash value without owing any tax as long as the policy stays in place. That means in any given year, if you need to withdraw more than you expected, you can use your life insurance cash value (instead of selling market-based investments) to avoid crossing into a higher tax bracket.

Life insurance can help you create guaranteed income in retirement

If you want guaranteed income in retirement and don’t have a need for your life insurance anymore, you can do something known as a 1035 exchange for an annuity. A 1035 exchange allows you to trade one insurance policy for another without owing tax at the time you make the exchange.

Say you have $200,000 in cash value. You could exchange some or all of that value for an annuity that will send you regular payments for as long as you live.

Life insurance can help ease concerns over spending down your other assets in retirement

Perhaps you want to leave something behind for your family. Or maybe you’re in a position where you need to fund care as your spouse’s health deteriorates. When you’re concerned about spending down your assets, you can find yourself making difficult choices.

Permanent life insurance can free you to spend down your assets on what’s most important to you while you’re alive—the death benefit can replenish assets for your spouse to generate income, fund your legacy or both. It’s a flexible asset to use as you need to.

Can I use term life insurance to plan for retirement?

Term life insurance differs from permanent life insurance in that it only provides a death benefit if you die within a specified timeframe (say, 10 or 20 years, or until you reach a certain age), and it does not have a cash value component. So while the death benefit could help you leave something behind for your family, it’s lack of cash value doesn’t provide any living benefits for you in retirement.

Building a retirement plan that works for you

Building a diversified retirement plan will give you flexibility down the road to continue working toward your goals in retirement while adapting to whatever life throws at you. Permanent life insurance can be a flexible addition to your retirement plan, thanks to the potential its cash value offers.

Utilizing the accumulated value through policy loans, surrenders, or cash withdrawals will reduce the death benefit; and may necessitate greater outlay than anticipated and/or result in an unexpected taxable event.

CAUTION: Loans taken against a life insurance policy can have adverse effects if not managed properly.  Policy loans and automatic premium loans, including any accrued interest, must be repaid in cash or from policy values upon surrender, lapse or the death of the insured.   Repayment of loans from accumulated values upon surrender or lapse can trigger a potentially significant tax liability and there may be little or no cash value remaining in the policy to pay the tax.   The policy will lapse if loans become equal to the cash value while the policy is in force and additional cash payments are not made.

This publication is not intended as legal or tax advice. Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation.

This article is provided by Northwestern MutualLearn more about saving for retirement from a licensed financial advisor using our one-of-a-kind Find An Advisor tool.