The Retirement Strategy Many People Overlook—But Could Supercharge Your Savings

Living comfortably during your golden years heavily depends on your ability to set up sources of retirement income that will augment modest Social Security payouts. Establishing retirement funds such as a 401(k) or Roth IRA is a common way people fund their retirements, but there’s another mechanism to boost retirement income while offering the benefit of a payout to your loved ones in the case of your death: life insurance.

Indeed, certain life insurance plans can provide a supplemental source of retirement funds that bypass taxes (as long as you follow the rules) while making your portfolio less dependent on the markets, providing financial security in the face of unexpected situations. You can borrow against your balance, typically at lower rates than other types of loans.

Types of Policies That Provide Additional Income in Retirement

Term Life Insurance

If you need a life insurance policy that will provide supplemental retirement income, term life insurance is not what you’re looking for. Rather, term life insurance strictly provides the basic protection of death benefits in the case of your passing. 

Term life is popular with buyers who are looking to save money.  These plans are lower-cost and provide coverage for a set period, typically terms of 10, 20, or 30 years.

Note: The affordability comes in through the fact that premiums remain the same throughout the length of the policy. If you die, your designated beneficiary (or beneficiaries) receive the death benefit.

“Think of term insurance like paying your car insurance,” said Steven Conners, founder and president of Conners Wealth Management in Scottsdale, Ariz. “As you pay, you’re covered. Should you stop paying your premium, you do not have insurance then.” 

He added, “You don’t want to think about [term life] for retirement. It’s just the lowest cost if that’s what you can afford and you need the coverage.”

Conners went on to say that term life may be more for peace of mind rather than financial security. According to his own studies, people typically outlive their term life insurance policies, with only 2% to 3% of death benefits being paid out.

Whole Life Insurance

As its name suggests, whole life insurance policies will stick it out with you to the end. Not only do they provide a death benefit in the case of your passing, but they also accrue value the more you pay into them. 

Whole life polices accumulate cash value–typically, tax-deferred–no matter which way the market is trending.

Speaking of those payments, how much you’ll pay depends on your coverage amount—basically, how much will be paid out when you die—your age and your health. Health factors include any recurring conditions and whether you smoke. Once the insurance company calculates your premiums, your payments, whether monthly or annually, will remain the same.

Whole life insurance policies can enhance retirement income because many of them pay out dividends—as long as they are participating whole life plans. When the company is doing well financially, a company will issue its policyholders a dividend, which Conners said could provide an internal rate of return of around 5%, depending on the policy.

The cash value of the policy will not provide significant income until after the cash value has built up. This usually takes several years of premium payments, according to Northwestern Mutual. Policyholders can withdraw or take a loan against their policy, which reduces its cash value as well as the death benefit.

For these reasons, Conners said that whole life insurance policies are a popular investment vehicle on behalf of children, who pay low premiums and are easily approved (as long as they don’t have any major health conditions).

“It doesn’t move, they’re constant, and the cash value keeps growing,” Conners said of these policies.

Universal Life Insurance

Similar to whole life insurance, universal life insurance also provides death benefit coverage and accrues value over the course of your life. But there are notable differences.

These policies offer flexibility. Policyholders can raise or lower premiums, although Guardian notes that doing so can impact the cash value of the policy and ultimately, the death benefit. 

“It’s not that the return is so great that people are stepping over to get life insurance policies because they’re that much better than other investments,” Conners said. “It’s because they may be the same as other investments. However, the money can grow tax-free.”

Ways Life Insurance Can Enhance Your Retirement Income

Supplemental Income

Along with more traditional retirement income sources such as a 401(k), Roth IRA, pension, and/or Social Security, holders of certain life insurance policies can use the balances of their accounts as a supplemental source of retirement income. 

In the case of a whole life insurance policy, the growth of your balance comes in the form of dividend payments. With a universal life policy, the growth comes from interest or returns from the indexes the policy is invested in.

Unlike those other sources of retirement income, life insurance policies are not directly impacted by the stock market. As long as you’re keeping up with your contributions, you can expect a nice chunk of change to be available to you to spend how you wish during your golden years.

Tax-Deferred Growth

There are a handful of investments whose gains are not subject to taxes. These include 529 plans for children, Roth IRAs, certain bonds, and arguably the employer-matched funds of a 401(k) account. According to Craig Ferrantino, founder and principal of Craig James Financial Services in Melville, NY, investment-grade life insurance also falls into this category.

“There’s very few in that tax-free category, so we like it in our toolbox,” he said.

Again, withdrawing from a life insurance policy will be tax-free as long as the policy is in effect and you stay within the limits allowed by the government (known as the modified endowment contract).

Financial Security

Financial advisors, including Ferrantino, recommend life insurance policies such as whole life insurance because, compared to other investments, insurance companies are relatively stable. First off, most are private companies, meaning they’re not subject to the whims of the market or profit-hungry shareholders. They’re also rated by outside agencies such as Fitch, Moody’s, or AM Best, who evaluate whether they have cash on hand to cover all their expenses. Financial advisors recommend sticking with the A-rated companies.

“We don’t see a lot of insurance companies going out of business, either to get sold or something,” he said. “It’s very unlikely that they’re going to fold. So you are going to keep continuing to get your benefits.”

These policies also provide financial security because of their death benefits, Conners said. Even if you have liabilities before your passing, you can feel secure knowing that your family members won’t be burdened by them because of the death benefit payout.

Portfolio Diversification

All savvy investors know not to put all their eggs in one basket. Holding too many assets in one category—such as energy, tech, or retail—can leave your portfolio in the red since these assets in the same category tend to move in the same direction together. When you hold a whole life insurance policy that pays out dividends, it’s mostly segregated from market forces. Universal life policies are more tied to the markets, but many plans protect policyholders from losses.

“It’s a non-correlated asset, so if the stock market crashes, so what?” Conners said. “The worst return you could ever get in an index universal life policy is no credit that year.” It’s worth noting that policy fees still apply even in zero-return years.

Longevity Protection

With any retirement account, there’s always the danger of you outliving your benefits. As lifespans have increased, there’s a danger of using up all your retirement funds. Having a life insurance policy as an additional source of retirement income could alleviate those concerns.

“It’ll give you a guaranteed payment or add to your pension every year for as long as you live. That’s longevity protection,” Ferrantino said. “If you don’t live so long, then it’s nice to know you won’t run out of money.”

Conners added that many of the retired clients he works with who find themselves in the ideal situation of having little debt feel safe knowing they have this additional account to tap into that doesn’t carry the same risks of taxation that other retirement accounts can carry.

1035 Exchange

If you find yourself in a situation in which your life insurance policy won’t be as beneficial to you as you had initially expected, the IRS allows you to move the cash value of the policy to something similar, without tax consequences.

According to the IRS, “1035 provides non-recognition treatment for taxpayers who have ‘merely exchanged an [annuity contract] for another better suited to their needs and who have not actually realized gain. …The contracts exchanged must relate to the same insured, and the obligee or obligees under the contract received in the exchange must be the same as those under the original contract.”

The Bottom Line

Those looking to diversify their retirement income should consider a life insurance policy. Not only do these policies provide peace of mind due to the death benefit they bestow to your beneficiary, but they’re also a way to earn extra income, either through dividends with a whole life policy or interest payments through a universal life policy.