Life Insurance: Retirement's Friend Or Foe?

Life insurance is a complex topic, and the decision to keep it into retirement depends on your financial and family circumstances. While it's not mandatory, life insurance can help your loved ones after you pass away, especially if you have debt or financial dependents. If you're debt-free, have prepaid your final expenses, and don't want to leave a large inheritance, you probably don't need life insurance in retirement.

Final expenses

Final expense insurance, also known as burial or funeral insurance, is a type of whole life insurance policy that is typically less expensive and designed to help loved ones prepare for the costs that arise in the final stage of life. These costs can quickly add up to thousands of dollars and include funeral and burial expenses, legal and accounting costs, and out-of-pocket medical bills.

The median cost of a funeral is around $8,000, and this does not include other expenses such as probate costs, which can take months or even years to resolve. Final expense insurance offers a competitive, fixed premium that does not change over time and provides a cash benefit to help cover these various end-of-life costs.

Final expense insurance is popular among seniors due to its affordable price, smaller benefit amounts, and emphasis on covering funeral costs. It is also easy to qualify for this type of insurance, as it usually does not require a medical exam, only a brief health questionnaire.

When considering final expense insurance, it is important to review the policy carefully, as not all policies are the same. Some policies may include additional features such as child riders, accidental death and dismemberment, or support benefits for surviving loved ones. It is also important to note that the death benefit can be used for anything by the beneficiary, even if the policy was taken out specifically to cover funeral costs.

In summary, final expense insurance can provide peace of mind and financial protection for individuals and their families during a difficult time. By helping to cover the various expenses that arise at the end of life, it can allow loved ones to focus on healing and grief without the added stress of financial burden.

Estate taxes

Firstly, if the payout is structured as multiple payments over the life of the beneficiary, these payments may be subject to taxes. For example, if the beneficiary receives regular annuity payments that include proceeds and interest, these payments may be taxable.

Secondly, if the policyholder has withdrawn money or taken out a loan against the policy, and the amount withdrawn exceeds the total amount of premiums paid, the excess may be taxable.

Thirdly, if you surrender your policy, any funds received over and above your policy's cash basis will be taxed as regular income.

Fourthly, in the case of an employer-paid group life plan, the Internal Revenue Service (IRS) may consider payouts over $50,000 to be taxable.

Finally, and most significantly, if the death benefit and the total value of the deceased's estate exceed the federal estate tax threshold (which was $12.92 million as of 2023), estate taxes must be paid on the proceeds over the allowed limit. This is an important consideration for individuals with substantial assets, as life insurance proceeds can significantly increase the value of an estate and trigger estate tax liability.

To avoid estate taxes, individuals can transfer ownership of their life insurance policies to another person or entity, or establish an irrevocable life insurance trust (ILIT). However, it is important to be mindful of the three-year rule, which states that gifts of life insurance policies made within three years of death are still subject to federal estate tax. Consulting with a qualified tax professional or financial advisor can help individuals make informed decisions about their life insurance policies and potential estate tax implications.

Inheritance

Keeping life insurance into retirement can be a good idea if you want to leave an inheritance for your loved ones. Here are some key points to consider:

The Benefits of Life Insurance for Inheritance

Life insurance can be an effective way to pass on money to your heirs or beneficiaries. The death benefit from a life insurance policy is typically tax-free and goes directly to the beneficiaries, providing financial security and peace of mind. This can be especially important if you have children, as it ensures they will be taken care of financially even after you're gone.

Types of Life Insurance for Inheritance

There are two main types of life insurance to consider for inheritance purposes: term life insurance and permanent life insurance. Term life insurance covers a set number of years, such as 10, 20, or 30 years, while permanent life insurance can last your entire life. Term life insurance is generally more affordable, but if you outlive the policy, your beneficiaries won't receive a payout. On the other hand, permanent life insurance, such as whole life insurance, can provide long-term coverage, but larger policies can be quite expensive.

Additional Considerations

When deciding whether to keep life insurance into retirement for inheritance purposes, consider your age, health, and budget. Life insurance rates are based on these factors, and if you're older or have pre-existing health conditions, the cost of coverage may be prohibitive. Additionally, if you have no debts, your family is financially secure, and you have no concerns about settling your estate, you may not need life insurance for inheritance purposes.

In conclusion, keeping life insurance into retirement can be beneficial if you want to leave an inheritance, especially if you have financial dependents. However, it's important to weigh the costs and benefits based on your individual circumstances and seek advice from a financial planner or insurance expert.

Debt repayment

Life insurance can be used to pay off debt, although it's worth noting that debts are rarely inherited. However, there are instances when an outstanding balance can become the responsibility of others. In such cases, a life insurance policy can be used to cover the amount owed, with the payout helping beneficiaries pay it off.

Using Life Insurance to Pay Off Debt

If you have the right type of life insurance – such as whole life or universal life – and have been making timely payments for an extended period, you may have accrued enough "cash value" in the policy to cover your debt. This can be particularly useful if you are unable to qualify for a debt management program or get a loan from a bank.

Pros of Borrowing from Life Insurance

• You are essentially borrowing from and paying yourself back.
• You can use the money for anything without having to explain yourself.
• There is no requirement to pay back the principal, only the annual interest on the loan.
• Credit scores do not matter, and there is no credit check.
• No impact on your credit score, as payments (or missed payments) are not reported to credit bureaus.
• The interest rate on life insurance loans is usually considerably lower than that of credit cards and should be less than that of a consolidation loan.

Cons of Borrowing from Life Insurance

• It may not be available with your life insurance policy, as most consumers have term life insurance, which does not have a cash value.
• You must make payments on the insurance policy for an extended period, typically at least 10-20 years.
• You will lose some of your death benefits if you don't repay the loan.
• You must be the policy owner.
• Life insurance benefits are protected from creditors, unless you take out the cash value in the form of a loan.

Tax Implications

There are usually no tax implications for taking out a loan against your insurance policy. However, if there is not enough cash value and/or premiums, and the policy lapses, you could have a taxable event. Therefore, it is always prudent to seek advice from a financial advisor, insurance agent, or credit counselor before making a decision.

Income replacement

Life insurance is a commonly used tool to protect against potential income loss. It offers a tax-free, lump-sum payout to beneficiaries in the event of an untimely death. This not only means your family will have enough money to cover the loss of your income, but they will also have more flexibility.

When deciding on a life insurance policy, it's important to consider your income, debt, estate plan, and the self-sufficiency of your children. There are two main types of life insurance: term life insurance and whole life insurance. Term life insurance is temporary and offers coverage for a set period, usually 10 to 30 years. Whole life insurance, on the other hand, is permanent and does not have an expiration date as long as premiums are paid. It is also more expensive than term life insurance because the insurer will have to pay out at some point.

When calculating how much life insurance you need to replace your income, a common guideline is to multiply your annual salary by the number of years you want to cover. For example, if you earn $60,000 per year and want to provide your beneficiaries with five years of coverage, you will need a $300,000 policy. It is recommended to consult a fee-only financial advisor to determine the appropriate amount of coverage for your specific situation.

Frequently asked questions