How Life Insurance Can Help Create More Flexibility in Retirement

Sean McGinn is an assistant director of Product Positioning in the Insurance Solutions department at Northwestern Mutual.

A lot can change once the kids move out and the house is paid off. Some of your biggest financial obligations are now behind you. As a result, you may also feel like you no longer need life insurance coverage.

But many people are surprised to learn that life insurance can be a source of stability in retirement planning. While permanent life insurance isn’t a replacement for retirement accounts or investing, it can complement them by providing lifelong protection¹, guaranteed cash value growth, and additional financial flexibility that can help you weather market volatility and economic uncertainty.

In fact, research has found that a financial plan involving permanent life insurance (such as whole life insurance), income annuities, and investments is more likely to outperform an investment-only approach over the long term.

Permanent life insurance can provide stability to your retirement plan

Permanent life insurance can be a source of financial stability, with a guaranteed death benefit that won’t expire and tax-advantaged cash value that you can access after a period of accumulation. This means it can help you with several major financial goals in retirement. Here are some ways permanent life insurance can be used.

Life insurance can protect your assets and legacy in retirement

The death benefit from whole life insurance can give you peace of mind that your family will be taken care of when you pass. It also has many strategic uses, including:

• Funding your legacy goals,
• Replacing lost income such as a pension or Social Security,
• Helping cover, reimburse, or replenish assets spent on medical or long-term care costs in retirement,
• Preserving estate tax liquidity,
• Establishing estate equalization to avoid liquidating assets at death,
• Providing funds that may help pay the income taxes associated with a Roth conversion, and
• Paying out guaranteed lifetime income for the beneficiary.

Life insurance can help you weather down markets in retirement

Think of retirement assets as having different jobs. Investments may help generate growth and keep pace with inflation. Permanent life insurance can provide a source of value that is not directly tied to market performance. Having both may give you greater flexibility when deciding where to take income from during retirement.

With whole life insurance (one of the types of permanent life insurance), your cash value is guaranteed to grow from one year to the next and won’t decline with the markets. 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).

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

Life insurance can help you create guaranteed income in retirement

If you need money to cover an expense, take advantage of an opportunity, or just to supplement your income, you may choose to access accumulated cash value through withdrawals or policy loans. Another option is to exchange the value of your life insurance policy for an annuity through a 1035 exchange. This allows you to trade one insurance policy for another without owing tax at the time you make the exchange, which can convert accumulated value into a stream of guaranteed income payments.

Life insurance can provide 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 owe 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. That means you’ll have to withdraw more from your retirement accounts to cover the expense. The larger withdrawals may put you into a higher tax bracket. If that happens, you’ll have to withdraw even more money to cover the additional tax.

Here’s an example of what we mean:

As you can see above, it’s helpful to have a mix of taxable and nontaxable 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, so long as the policy stays in place, you’re able to borrow against your cash value without owing any tax. 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 accessing taxable sources of income) to avoid crossing into a higher tax bracket.

It’s also worth noting that the example above uses today’s tax rates.

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 long-term care as your spouse’s health deteriorates. When you’re concerned about spending down your assets, you may 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.

Term life insurance and retirement

Term life insurance can be used for retirement but with some limitations. Term life insurance differs from permanent life insurance in that it provides a death benefit only if you die within a specified time frame (say, 10 or 20 years or until you reach a certain age), and it does not have a cash value component. So the death benefit could help you leave something behind for your family if the policy remains in place. But because term policies don’t generate cash value, they don’t provide any living benefits for you in retirement.

Who may benefit most from life insurance for retirement planning?

While it may not be suitable for every situation, permanent life insurance can be a flexible addition to your retirement plan, thanks to the potential its cash value offers.

It may be useful if you:

• Want permanent life insurance coverage.
• Value predictable growth and guarantees.
• Want more tax diversification in retirement.
• Are interested in leaving a financial legacy.
• Need another source of funds that may be available during market downturns.

But if your primary goal is temporary coverage at the lowest possible cost, term life insurance may be a better solution.

Your Northwestern Mutual financial advisor will talk through your options and show how life insurance can be a valuable part of your retirement plan. They can also help you plan for the retirement you’ve dreamed of, providing stability, growth, and the freedom to focus on what truly matters.

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.

All investments carry some level of risk, including loss of principal invested.

Frequently Asked Questions

Can a life insurance policy be used for retirement?

Yes. Certain types of life insurance, particularly permanent life insurance, can be used as part of a retirement plan because they build cash value that may be accessed during your lifetime. Depending on how the policy is structured and used, that cash value can provide retirement income flexibility, tax diversification, and an additional source of funds during market downturns. However, life insurance is generally most effective when used alongside retirement accounts and investments, not as a replacement for them.

Which life insurance is best for retirement?

Permanent life insurance can carry added value in retirement planning because it provides lifelong coverage and can build cash value over time. Whole life insurance is one type of permanent life insurance that offers a guaranteed death benefit and guaranteed cash value growth. Term life insurance can still play an important role in a financial plan, but because it does not build cash value, it typically offers fewer retirement-planning benefits. The best option depends on your goals, budget, need for protection, and overall financial plan.

Do I lose my life insurance when I retire?

Only if you choose to. Really, whether you keep your life insurance after retirement depends on the type of policy you own. Permanent life insurance is designed to provide coverage for your entire life as long as policy requirements are met. Term life insurance, on the other hand, provides coverage for a specific period and may expire before or during retirement. Many retirees maintain life insurance to help protect a spouse, support legacy goals, provide cash for estate planning, or maintain access to policy cash value.