Life insurance for retirement and estate planning

Life insurance does more than cover basic expenses after you die. Find out how a policy can support retirement, end-of-life care, and a future for your loved ones.

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Amanda Shih

Amanda Shih

Editor & Licensed Life Insurance Expert

Amanda Shih is an editor and a licensed life, disability, and health insurance expert at Policygenius, where she writes about life insurance and disability insurance. Her expertise has appeared in Slate, Lifehacker, Little Spoon, and J.D. Power.

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Mike Hogan

Mike Hogan

Senior Manager, Case Management

Mike Hogan is a life insurance expert and Senior Manager of the life case management team at Policygenius.

Updated December 9, 2021 | 5 min read

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Most people want their retirement planning to address a few key things: maximizing retirement savings, covering the cost of long-term care or a funeral, and providing for loved ones when they're gone.

Life insurance can support all of these goals. Read on to learn about plans and riders that can help you prepare for your golden years.

Key Takeaways

  • Policies with a cash value are another avenue for retirement savings if you’ve maxed out 401k or IRA options.

  • You can earmark funds for costly end-of-life events with final expense and long-term-care policies.

  • The death benefit can be a tax-free inheritance for your dependents.

  • An irrevocable life insurance trust protects your death benefit from estate taxes.

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Invest in your retirement with life insurance

When people suggest using life insurance as a retirement savings vehicle, they’re generally referring to a permanent life insurance policy with a cash value amount like whole life insurance. The cash value of these policies earn interest, and you may be able to borrow against the amount or cancel the policy and take the cash value with you.

Life insurance retirement plans

When you buy a policy with a cash value, that value accrues interest — as set out in your policy contract — as long as you keep paying your premiums. After it grows, you can use that cash value to supplement your retirement.

Unlike a standard retirement fund, there are different rules around how much you can contribute to your life insurance cash value and many insurers guarantee a minimum return on your investment.

Beware of modified endowment contracts (MECs): when a cash value life insurance policy is overfunded and exceeds federal tax limits. When a permanent life insurance policy becomes an MEC, you'll pay taxes and a 10% fee to access your money before age 59 ½.

Policy loans and cash surrender

Some cash value insurance also allows you to take a loan against your policy or keep the cash value if you surrender the policy. Taking a loan against your policy might help you pay for unexpected expenses, but there may be some restrictions on borrowing. And if you don’t pay back the loan with interest, the insurer will take what you owe out of the death benefit.

If you surrender your life insurance policy, you’ll walk away with the current cash value amount — minus taxes, fees, and administrative costs — as long as you’re out of the policy’s surrender period. Of course, taking the cash value in this scenario means canceling your policy, so you should have a life insurance plan going forward.

Pros and cons of investing in life insurance

Investing with your life insurance policy is worth considering if you’re an aggressive saver who maxes out your 401k and IRA contributions each year but doesn’t want to put your remaining savings in a traditional investment account.

For most people, a 401k or IRA is a safer option. These accounts typically have a higher rate of return, and tying your retirement savings to a significantly more expensive permanent life policy puts you at greater risk of losing out if you let the policy lapse.

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Life insurance for end-of-life expenses

A key concern in retirement planning is the cost of medical care and other end-of-life expenses. If you want to earmark money for specific needs like a funeral or nursing home care, some life insurance policies and riders offer that flexibility.

Long-term-care insurance

Of adults who live to age 65, 70% will ultimately require some form of long-term care before they die. [1] Long-term-care policies support the costs associated with chronic illnesses and old age, such as memory care facilities, home health care, and nursing home care.

Long-term care insurance can be costly and may be too expensive to buy when you reach retirement age, but it's worth considering if you anticipate needing specialized care as a senior. You may also consider adding a long-term-care rider or accelerated death benefit rider to a term policy, which may increase your monthly premium but likely cost you less than long-term-care insurance.

Final expense insurance

Final expense insurance is a type of permanent insurance in which the death benefit is meant to go toward end-of-life expenses. This type of policy doesn’t require a medical exam and remains in force as long as you pay the premiums, but the death benefit is lower than you’d receive through a term life policy.

Final expense policies don’t require the beneficiary to use the death benefit for final expenses, so make sure your beneficiary is aware of your intentions. Most people put the death benefit toward medical expenses and things like a burial, funeral, or casket.

Pre-need insurance

If you’re primarily concerned with burial and funeral costs, a pre-need policy essentially allows you to plan your funeral in advance. You enter into an agreement with a funeral home or director for their services at a set cost so that your loved ones don’t have to worry about the details or payments. However, these plans usually cost more than other, more flexible life insurance policies and might not be honored if the funeral home closes or its ownership changes.

Protect an inheritance with life insurance

If you’ve saved up for end-of-life expenses, the death benefit can easily become a nest egg for your loved ones. And for high-net-worth individuals, life insurance is one tool for managing your estate taxes.

Inheriting the death benefit

As long as its paid in a lump sum, the death benefit passes to your beneficiaries tax-free after you die. You can designate portions of your policy to any of your loved ones who might need financial support when you’re gone. That could be your parents, your children, or loved ones who might need specialized care into adulthood.

Managing estate taxes

While the death benefit is generally not taxable, the benefit amount is factored into the overall value of your estate in some circumstances. High-net-worth individuals may create an irrevocable life insurance trust to remove a life insurance policy from their assets.

It might be enough for your beneficiaries to apply some or all of the death benefit to the estate tax, then financially support themselves using the assets distributed in your will. Some couples choose to use a survivorship policy for this purpose, since the death benefit isn’t available until both policyholders die.

A life insurance policy can be a helpful tool, no matter what your family's financial needs. If you want to establish a trust or use your life insurance policy to supplement your retirement, be sure to work with an estate planning attorney and certified financial advisor to make your plans.

Frequently asked questions

What role does life insurance play in estate planning?

Life insurance protects your loved ones after you die. Policy proceeds can be used to establish an inheritance or pay debts and estate taxes.

Is life insurance money considered part of an estate?

Life insurance payouts aren't considered part of an estate for tax purposes as long as they're paid directly to beneficiaries.

What type of life insurance is best for estate planning?

It depends on your estate planning needs. If you need lifetime coverage, a permanent life insurance policy is the best choice.