When it comes to retirement planning, diversification is the gold standard in terms of strategy. Many investors diversify by looking into bonds, index funds, or different market sectors and capitalization levels.
But there’s an often-overlooked way to diversify your portfolio that reduces risk, provides supplemental retirement income, and helps provide an inheritance for your children or a generous gift to your favorite charity: life insurance.
Diversification Strategy: Cash Value Life Insurance
Even savvy investors may not know that certain types of life insurance do much more than provide your family with money after you pass away. Permanent life insurance — a policy type that covers you for the rest of your life — also builds cash value over time.
Many investors use this cash value to supplement their retirement income, making up for any shortfalls in projected income due to shifts in the market. In short, your policy’s cash value functions as a financial safety net, with some tantalizing tax benefits.
There are four key benefits to a cash value life insurance policy:
- Tax-free growth. A portion of every premium payment you make funds your cash value account, which then earns interest. That money grows tax-free, giving you the benefit of compound interest. Some types of permanent life insurance (such as indexed universal life) let you tie your cash value growth in part to gains in a particular market index, such as the S&P 500, instead of a set interest rate.
- Tax-free retirement income. Suppose your current retirement plan includes paying for all your expenses with a combination of your investment dividends and Social Security. But what happens if those investment dividends don’t live up to your expectations? Or what if your expenses are more than you planned? You can access the money in your policy’s cash value account tax-free, up to the total amount you’ve paid into the policy so far. If you need to withdraw more than you’ve paid in, you can do so with policy loans, and even choose not to pay them back to yourself. Still, the sooner you buy a policy and let the cash value build, the more you’ll have to pull from during retirement.
- Penalty-free withdrawals. Traditional retirement accounts such as 401(k)s and IRAs have strict rules about when you can start taking distributions. If you try to access that money before age 59½, prepare for stiff penalties. On the other hand, you’re also penalized if you don’t begin taking distributions by age 70½, whether you need the cash or not. A life insurance cash value account does not have a minimum or maximum age by which you need to take certain actions. If you need the money, you may access it. If you don’t need it, simply let the compound interest accrue.
- Cash value pays for your policy. If your investments perform as expected and you don’t need supplemental retirement income, your cash value won’t go to waste. You can opt to have it pay your policy’s premiums, reducing your expenses during retirement and guaranteeing your heirs the peace of mind that comes with a tax-free death benefit.
Cash value life insurance is a diversification strategy that can reduce your market-related risk. In addition to the standard benefits paid to your family after you pass away, a cash value policy can also provide supplemental retirement income with substantial tax advantages.
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Joe Stark is the CEO of Crown Atlantic Insurance, LLC in Boca Raton, Fla. Stark is an insurance industry veteran with more than 25 years of experience. For more of his reports, Go Here Now.
If you are considering a life insurance policy, we suggest that you consult with your own legal or tax professional to confirm how the tax treatment of a life insurance policy may apply to you.
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