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Ask the Retirement Expert: What Are My Options to Use Life Insurance Cash Value to Supplement Retirement Income?

Craig Volk, RICP® •  May 6, 2016 | Enjoying Retirement, Your Finances, Ask the Expert

Each week our Northwestern Mutual retirement experts answer your questions. This week’s question:

I’m interested in using cash value I have accumulated in my life insurance to supplement retirement income. What are my options?

While the primary purpose of life insurance is the death benefit, you may have purchased a permanent policy that accumulates cash value and grows on a tax-deferred basis.

By Craig Volk

In April of 2000, Craig began his career with Northwestern Mutual. As a Wealth Management Advisor and Retirement Planning Specialist, Craig’s practice focuses on an integrated planning approach involving retirement distribution planning, investment management and wealth distribution.

Once they reach retirement, many people may be interested in utilizing the cash value at some point to supplement their income. Utilizing your cash value will reduce your death benefit. However, given your particular planning needs that may make sense once you get to retirement. If you’re interested in using your cash value, you have several options.

Withdraw your cost basis. Generally, you can take out as much money through withdrawals or surrenders as you paid in premiums tax free (this is referred to as your cost basis). This will reduce your death benefit. However it may allow you to get back what you paid in while still leaving some death benefit in place for your legacy planning. Participating polices may also allow you to take any dividend paid on the policy in cash each year.1

Use loans against your policy. You can take a loan against the cash value that has accumulated in your policy (both what you paid in and any growth). You could use this option to supplement income in years when the market drops. Some might also consider the combination of withdrawing the cost basis first and then subsequently utilizing loans. Since policy loans incur interest, it’s important to work closely with your financial professional to avoid a potential negative tax consequence. Read more about that here.

Use a 1035 exchange to annuitize the policy. If your desire is to generate a stream of income instead of maintaining a death benefit, you could use a 1035 exchange to turn the policy cash value into an annuity. It’s essentially a tax-free exchange. You are giving up the life insurance policy, both the death benefit and the cash value, in order to generate an income stream. Your policy may also directly offer the ability to provide a lifetime income settlement option in exchange for its cash value.

Surrender the policy. Get rid of your life insurance, and take the cash value. When you do this, you surrender the policy. You give up the death benefit, and receive the cash surrender value. You will pay tax on any gain in the policy (basically the amount of your cash value minus then net amount you paid in premiums).

Always remember, your decision should be made as part of a larger and more comprehensive financial plan that takes into account your entire financial picture and goals. You should consider:

  • Whether you have a desire to leave assets to your heirs or a charity. Life insurance death benefits are generally income tax free.
  • Whether you want to cover final expense needs and potential estate tax liabilities.
  • Whether you want the ability or have any other options to draw income during your retirement on a tax-advantaged basis.
  • Whether you will have a large required minimum distribution from retirement accounts starting at age 70 ½ or any other upcoming expenses.
  • Whether you have a desire to have a stable source to draw some income from after you retire. It’s important to note that, with a traditional whole life insurance policy, your premiums, a set of minimum cash values and a minimum death benefit is guaranteed never to go down.

A financial professional can help you think through questions like these and help you build and implement an insurance and retirement income plan, which may include the use of cash value from permanent life insurance.

Do you have a question for our Northwestern Mutual retirement experts? Click here to send your questions.

1 Dividends are not guaranteed.

This publication is not intended as legal or tax advice.  Financial Representatives do not give legal or tax advice. Taxpayers should seek advice based on their particular circumstances from an independent tax advisor. Utilizing the cash values through policy loans, surrenders of dividend values, or cash withdrawals will or could: reduce the death benefit; necessitate greater outlay than anticipated; or result in an unexpected taxable event. Assumes a non-Modified Endowment Contract (MEC).

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