Using 403(B) Money To Purchase Life Insurance: Is It Possible?

Life insurance is a legally binding contract that guarantees a death benefit to the policy owner when the insured person dies. It is a way to provide financial support to surviving dependents or beneficiaries after the death of the insured policyholder. On the other hand, a 403(b) plan is a retirement plan offered by public schools and certain tax-exempt organizations, which allows employees to contribute a part of their salary towards retirement savings. While life insurance and 403(b) plans serve different purposes, there may be instances where individuals want to know if they can purchase life insurance using their 403(b) money. This could be due to various reasons, such as not being able to afford life insurance premiums or wanting to maximize the use of their 403(b) funds. Understanding the rules and regulations regarding the use of 403(b) funds for life insurance is crucial for making informed financial decisions.

Can I use 403(b) money to buy life insurance?

A 403(b) plan is a retirement plan offered by public schools and certain 501(c)(3) tax-exempt organizations. It allows employees to contribute some of their salary to the plan, and employers may also contribute.

You cannot directly use 403(b) money to buy life insurance. However, you can take a loan from your 403(b) plan and use that money to purchase life insurance. Many 403(b) plans allow you to take a loan, but it should be a last resort as it comes with major problems and risks. The IRS limits these loans to 50% of your vested balance or $50,000, whichever is less. You will pay yourself interest on the loan, but there are other costs to consider, such as the returns you would get from keeping the funds invested.

Additionally, there are tax implications. The interest you pay yourself is treated as after-tax money, so you will pay taxes on it now and again upon withdrawal if you are using a traditional pre-tax 403(b) account. If you fail to repay the loan, it will be treated as a distribution and subject to early withdrawal penalties and taxes.

Another option is to withdraw money from your 403(b) plan and use it to buy life insurance. However, this is also not advisable as withdrawals are subject to taxes and fees.

Instead of using 403(b) money, it is generally recommended to buy a term life insurance policy and focus on investing in retirement plans such as a 401(k) or IRA.

What are the tax implications of using 403(b) money for life insurance?

The tax implications of using 403(b) money for life insurance depend on several factors, including the type of life insurance purchased, the timing of the withdrawal, and the individual's tax bracket during retirement. Here are some key points to consider:

• Tax-Deferred Growth: 403(b) plans are tax-deferred, meaning contributions are made with pre-tax dollars and grow tax-free until withdrawn. This lowers taxable income in the contribution years, providing tax advantages.
• Taxation upon Withdrawal: When funds are withdrawn from a 403(b) plan, they are typically taxed as ordinary income, and the rate depends on the individual's tax bracket during retirement. This includes both the original contributions and any associated earnings.
• Early Withdrawal Penalty: Withdrawing money from a 403(b) plan before the age of 59½ generally incurs a 10% early withdrawal penalty on top of the income tax owed on the distribution.
• Required Minimum Distributions (RMDs): Once the account holder reaches a certain age (73 for those born after 1950), they must begin taking RMDs. Failure to do so can result in a nondeductible 25% excise tax on the difference between the required minimum distribution and the actual distribution.
• State Income Tax: If the individual lives in a state with income tax, they will need to pay state taxes on the distributions during retirement, in addition to federal income taxes.
• Roth 403(b) Option: Some 403(b) plans offer a Roth option, which means contributions are made with after-tax dollars but can then grow tax-free, and qualified distributions are tax-free. This can be advantageous for those who expect to be in a higher tax bracket during retirement.
• Investment Options: The investment options available within a 403(b) plan may impact the tax implications. These plans typically allow investments in annuities or mutual funds.

What are the pros and cons of using 403(b) money for life insurance?

Using 403(b) money for life insurance has its pros and cons.

Pros

• The Employee Retirement Income Security Act places some limits on the amount of life insurance you can buy with 403(b) money, but the limits fall away after a few years.
• After five years, you can use your entire account balance to buy life insurance.
• The death benefit of a life insurance policy is usually tax-free.
• Life insurance can be a prudent financial tool to hedge your bets and provide protection for your loved ones in case you die while the policy is in force.
• Life insurance death benefits can help beneficiaries pay off a mortgage, cover college tuition, or help fund retirement.
• Life insurance policies also feature a cash value component that builds over time.
• Life insurance payouts are tax-free.
• Dependents don't have to worry about living expenses.
• Final expenses can be covered.
• Policies can supplement retirement savings.

Cons

• You can only buy 401(k) life insurance if your employer's plan permits it.
• You might be able to purchase group life insurance through your employer or buy an individual policy if your employer allows it.
• Initially, only half of your 401(k) premiums can pay for whole life insurance premiums. Only a quarter of your premiums can buy term or variable universal life insurance.
• Part of the premium you pay for 401(k) life insurance is current taxable income.
• You must include in your taxable income the annual premium on a term life insurance policy offered by the insurer of your 401(k) policy.
• The cost basis is the amount of taxable premiums you pay into the policy.
• The limits on 401(k) contributions might restrict how much life insurance you can buy in the plan.

How does using 403(b) money for life insurance compare to other options?

Using 403(b) money for life insurance is a viable option for those who want to protect their family's finances. However, it is important to note that there are certain restrictions and tax implications associated with this approach. On the other hand, other options for purchasing life insurance include buying it directly or through an employer-provided group plan. These alternatives may offer more flexibility in terms of investment choices and tax advantages.

One key difference between using 403(b) funds for life insurance and other options is the source of money. With 403(b) funds, the money comes from your retirement savings, which are specifically intended for retirement planning. In contrast, purchasing life insurance separately allows you to allocate funds specifically for that purpose, without dipping into your retirement savings. This separation can provide a clearer financial strategy and potentially more comprehensive coverage.

Additionally, when using 403(b) money for life insurance, there may be limitations on the amount of coverage you can obtain. The Employee Retirement Income Security Act places restrictions on the amount of life insurance you can buy with 403(b) funds, at least initially. Over time, these limits may be lifted, but it is important to carefully review the rules and regulations to understand the extent of coverage you can secure.

In terms of tax implications, using 403(k) funds for life insurance can offer certain tax advantages due to the tax-deductible nature of contributions. However, it is important to note that the tax treatment of life insurance policies can be complex, and there may be taxable events or consequences associated with the policy, such as taxes on the cash value of the policy or taxes on distributions. It is always advisable to consult with a tax professional to understand the specific tax implications for your situation.

When comparing the use of 403(b) money for life insurance to other options, it is worth considering the range of investment choices available. 403(b) plans typically offer a more limited selection, often including annuities and mutual funds. If you opt for an alternative life insurance policy, you may have access to a broader range of investment options, allowing for greater flexibility and diversification in your portfolio.

Furthermore, it is important to evaluate the fees and expenses associated with each option. 403(b) plans may have different fee structures than other life insurance policies, and it is crucial to understand the potential impact on your overall returns. Additionally, the portability of your policy is an important consideration. If you change jobs or retire, you will need to carefully review the options for continuing or adjusting your coverage, as there may be restrictions or limitations.

In summary, using 403(b) money for life insurance can be a viable option, especially for those who want to take advantage of the tax benefits associated with these plans. However, it is important to weigh this approach against other alternatives, considering factors such as investment choices, tax implications, fees, and portability. Seeking advice from a financial advisor or tax professional can help you make an informed decision that aligns with your specific needs and circumstances.

What are the steps to use 403(b) money to buy life insurance?

Using 403(b) money to buy life insurance can be a great way to protect your family's finances and provide for them after your death. Here are the steps you can follow to use your 403(b) funds to purchase life insurance:

Step 1: Understand the Basics of 403(b) Plans

Firstly, it's important to understand what a 403(b) plan is and how it works. A 403(b) plan is a retirement plan offered by certain employers, including public schools, churches, and tax-exempt organizations. It allows employees to contribute a portion of their salary to the plan on a pre-tax basis, and some plans also offer Roth contributions with after-tax dollars. The plan may be in the form of a tax-sheltered annuity, a custodial account invested in mutual funds, or a combination of both.

Step 2: Verify Your Need for Life Insurance

Before purchasing life insurance, ask yourself if you really need it. Life insurance is typically useful if you have financial dependents who will need resources after your death, if your estate won't have enough liquid assets to cover taxes and debts, or if you want to cover your funeral and burial expenses.

Step 3: Calculate the Required Coverage

Determine how much life insurance coverage you need by evaluating your financial resources, when these resources will be available to your survivors, and what your survivor's financial needs will be after your death. Subtract your survivors' financial resources from their needs to arrive at the necessary coverage amount.

Step 4: Set Your Financial Goals

Decide on the financial goals you want to achieve with your life insurance policy. This could include leaving behind financial resources for your loved ones, covering final arrangements, or supporting a charitable cause. Understanding your goals will help you choose the most suitable type of life insurance.

Step 5: Choose the Right Type of Life Insurance

There are different types of life insurance policies available, such as term life, whole life, and universal life. Term life insurance provides coverage for a specific term, such as 10 or 20 years, and tends to have lower premiums. Whole life insurance offers fixed premiums and a minimum rate of return, building cash value over time. Universal life insurance provides flexibility, with the potential to increase the death benefit or adjust premium payments.

Step 6: Consider Adding Riders

Riders are optional additions to a life insurance policy that provide supplemental benefits. Two important riders to consider are the waiver of premium, which pays the premium if you become disabled, and guaranteed insurability, which allows you to increase the death benefit without providing additional health evidence.

Step 7: Shop Around for the Best Coverage

Compare quotes from different insurance companies to find the most suitable coverage for your budget and financial goals. Working with an agent can be helpful, but ensure they understand your financial situation and can explain your options clearly.

Step 8: Decide on Payment Options

You may have the option to pay premiums annually or in smaller, more frequent installments. Weigh the cost implications of each option and choose the one that works best for you.

Step 9: Inform Your Beneficiaries

Once you've purchased the policy, inform your beneficiaries about the insurance company, the location of the policy documents, and any specific instructions regarding the death benefit.

Frequently asked questions