Strategies To Use Life
Insurance For Retirement
Can the right life insurance policy help you
meet your retirement savings goals? Yes, but maybe not in the way you’re
thinking. While life insurance agents will try to sell you on the benefits of permanent life insurance that accumulates cash value, such policies usually only make sense
for individuals with a net worth of at least $5 million, the threshold where estate taxes kick in after death.
For almost everyone else, the best way to
incorporate life insurance into your retirement-planning strategy is to get the
right death benefit for your family at the lowest cost so you have the most
money left over to take other key steps toward financial security. Let’s take a
look at how this strategy works.
Step 1: Buy Term
If you have a spouse or children who depend on
your income or who depend on your “free” services as a stay-at-home parent or
homemaker, life insurance should be part of your financial plan. In other
words, almost everyone needs life insurance. Even if you miss out on retirement
because of an early death, you’d still like your spouse to be financially secure
enough to have a chance at enjoying retirement, right? The least expensive type
of life insurance, not just considering your out-of-pocket expense but also
considering how much coverage you get for what you pay, is term life
insurance. (For related reading, see Insuring Against the Loss of a Homemaker.)
Life insurance prices vary significantly
depending on your age, health and policy features, but here’s one example that
shows how much extra cash you could have to work with if you buy term instead
of permanent life insurance. A nonsmoking, 35-year-old New York man in good
health, meaning his blood pressure and cholesterol might be a bit higher than
the ideal, might be able to get a 20-year term policy with a $1 million death
benefit for $1,030 per year. If the same man bought a whole life policy, a type of permanent life insurance, the
premium might be $14,090 annually for the same death benefit. That’s a $13,060
difference per year.
Given these costs, term life insurance can be an
ideal retirement savings tool in two ways. First, it provides the basic
financial protection your family will need if you pass away before you’ve
accumulated enough savings for them to live off of. Second, its low, fixed
price frees up more of your disposable income to create an emergency fund,
purchase long-term disability insurance and invest in low-cost funds.
How long a term you should buy depends on how
long you think it will take to amass enough savings for your family to live
comfortably without you. It also depends on your current age, because it can be
difficult to get term insurance past age 65. How much life insurance you should carry depends on how much debt you have, how much
income you need to replace and the cost of any future obligations you want to
fund, such as a child’s college tuition.
If you get life insurance as a benefit through
work, your employer-provided life insurance may not be enough; you
may need to supplement if with a policy you buy on your own. Also, if you want
the security of knowing that your insurance will be renewed each year as long
as you pay the premiums and of knowing that your premiums will be the same
every year for as long as the policy is in force, get a level-premium, guaranteed renewable and noncancellable term life insurance policy.
Step 2: Create an
Emergency Fund
The first way you should put the savings from
buying term life insurance to work is by building yourself an emergency fund of three to six months’ worth of expenses –
maybe more, if you’re really risk averse or have an irregular income. Having an
emergency fund prevents you from going into debt to handle times of increased
expenses or reduced income.
Avoiding debt means avoiding paying interest;
having to pay interest, especially at credit card rates, makes it that much
harder to recover from a setback. A financial emergency often means temporarily
stopping your retirement contributions; the sooner you can bounce back, the sooner
you can get back on track with your retirement savings.
Step 3: Protect Your
Income with Long-Term Disability Insurance
Ideally, you’d take this step at the same time
as you’re building your emergency fund; there’s no reason to wait. While many
people think they can get disability benefits from Social Security if a serious illness or injury prevents them
from working, it is hard to qualify for these benefits and they might be far
below what you’d need to maintain your household’s standard of living. What’s
more, you won’t qualify for those benefits if you haven’t paid into the system;
many public employees have not.
Among disability insurance policies, an own-occupation policy will cost you more than an any-occupation policy, but it will provide more comprehensive
coverage. If you’re unable to work in your own profession – say, accounting –
you won’t have to become a retail store greeter to get by; your disability
insurance will replace a significant percentage of your lost income. Again,
look for a guaranteed renewable and noncancellable policy, which ensures that
your premiums won’t increase and you won’t have to worry about requalifying.
You can keep the policy as long as you pay the premiums. Even if you're single
and don't have children to support, having disability insurance is still
important – maybe more so, as you don't have a spouse or other immediate family
to help you get by should you become seriously ill.
Choosing the best disability insurance means either purchasing your own policy to
protect your income and anyone who depends on it or making sure you have enough
coverage through your employer. As personal finance guru Dave Ramsey likes to
say, “your most powerful wealth-building tool is your income.” Without an
income, you have no way to save for retirement. (Learn more in our Intro to Disability Insurance.)
Step 4: Invest the Rest
You’ve got life insurance, an emergency fund and
disability insurance. Finally, let’s talk about investing the rest of the money
you’ve saved by using term life insurance as a retirement tool.
While permanent life insurance policies have a
cash value component that accumulates savings and can be invested, you’ll have
the greatest control over your money and the potential to earn the highest
returns if you invest it yourself, through the brokerage of your choosing,
rather than through a life insurance policy. You won’t pay the high policy fees
and agent commissions associated with permanent life insurance, your investment
performance won’t be tied to the life insurance company’s financial
performance, and you won’t be limited to the investments the insurance company
offers.
You can set up a tax-advantaged retirement
account at a brokerage that offers rock-bottom investment fees, which is one of
the keys to growing your portfolio. You can create a well-diversified portfolio
of uncomplicated index funds or exchange-traded funds. For even more hands-off investing,
consider a target-date fund, which – depending on the fund's strategy –
adjusts your portfolio mix to become more conservative as you get closer to
retirement age.
The Bottom Line
Buying term life insurance and investing the difference isn’t what
most people think of when considering how a life insurance policy can help meet
their retirement savings goals. Yet, for most people, it’s the most effective
strategy.