What are life insurance retirement plans?

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• Permanent life insurance policies are referred to as life insurance retirement plans due to their cash value component.
• While life insurance can supplement retirement income, it doesn't replace retirement plans like a 401(k).
• There are different permanent life insurance products and the cash value is earned differently based on how it's invested.
• Policygenius can help you compare life insurance policies to find the right coverage for you, at the right price »

Life insurance is multifaceted. It's generally used for its death benefit that loved ones receive after the insured's death, usually with term life insurance. Life insurance is less utilized for its ability to build wealth and as an investment tool during your lifetime, particularly with permanent life insurance policies that include a cash value that accumulates over time.

"Life insurance is for the living, not the deceased," Rosalyn Glenn, a financial advisor with Prudential, told Insider. "It's more than just something to bury me with."

Permanent life insurance policies include a cash value component that is sometimes used to supplement retirement income, with policy holders paying themselves a salary from the policy. But life insurance is not a replacement for retirement plans like a 401(k) or IRA account.

What are life insurance retirement plans?

The phrase "life insurance retirement plan" is generally used to refer to permanent life insurance products  — like whole life, universal life, and variable life insurance — due to the cash value component. 

But it's important to understand that permanent life insurance is insurance — not a substitute for retirement plans. "At the end of day, life insurance is risk management [against] premature death, loss of income due to illness, or disability," Silvia Tergas, a financial planner with Prudential, told Insider. 

What are cash value life insurance policies?

"Permanent life insurance is the only product that combines every tax favor benefit in the tax code," said Mike James, head of individual solutions and president of NFP Life Solutions. "You can put your money in and take your basis out without paying taxes. No other financial instrument does that. You can actually borrow against it without having to take out any principal. Plus, if you die, it will pay a death benefit to your heirs."

Cash value is a unique feature to permanent life insurance policies. All permanent life insurance policies have a cash value that grows on a tax-deferred basis. You can take a loan on the cash value or use it as collateral during your lifetime, tax deferred. 

Permanent life is one of many tools that help you plan and save for the future

According to Mark Williams, CEO of Brokers International,"in the early years of overpayment, the cash value put inside the policy earns interest and you use that bucket of money to offset the cost of insurance when you're older." 

This is why permanent life insurance is considerably more expensive than term life insurance . The big difference between the various types of permanent life insurance policies is how they manage the cash value — such as investing it in the insurance company's portfolio or in the stock market.

The cost for permanent life insurance depends on your death benefit amount and the type of policy you choose: whole, universal, variable, guaranteed universal, indexed universal, and variable universal. It's best to consult with a financial advisor regarding the tax benefits and which permanent life insurance product suits your situation and needs.

The cash value can be used to pay your children's college tuition, fund a business, purchase a second home, or supplement income during retirement. Some financial planners have also suggested that permanent life insurance is a good tool to close the racial wealth gap. 

Permanent life insurance vs 401(k) and IRA plans

Williams says you should be maxing out your 401(k) before using permanent life insurance as an investment tool. Williams used the example of a person making $200,000 in salary who has maxed out their annual contributions to 401(k) and IRA accounts and have nowhere else to put money tax deferred so they use permanent life insurance. 

The IRS limits contributions to an IRA to $6,000 per year for those age 49 and under and $7,000 per year for those 50 and over. It also limits contributions to an employer-sponsored 401(k) to $19,500 per year. Therefore, the maximum amount a person can contribute to an IRA and 401(k) is $25,500 per year.

If you don't have access to a qualified plan like an employer-sponsored retirement account, permanent life insurance is a good tool to save for retirement. But the cash value of your permanent life insurance policy shouldn't be your entire retirement savings plan.

Who needs permanent life insurance?

High-net-worth individuals — those with at least $1 million in liquid assets — often have permanent life insurance policies for tax benefits, education endowments for colleges and universities, and charitable gifts. 

But you don't need to be wealthy to get permanent life insurance. Think of permanent life insurance coverage like equity in a home. Start with a smaller death benefit if you can't afford higher monthly premiums, and increase it over time. 

Maria Roloff, a wealth advisor at Northwestern Mutual Insurance, recommends clients "blend insurance — some permanent and term life— to fit in their budget allowing for maximum coverage." 

Mark Williams advises that people take a holistic view when it comes to financial planning that includes estate planning and life insurance. He said buying life insurance alone without a big-picture outlook of your financial plan isn't wise because there are varying risks associated with the different permanent life insurance products.

Williams said that people who no longer need a death benefit and whose adult children are independently wealthy can sell their permanent life insurance policies. Talk to a financial advisor, estate lawyer, and accountant to get customized life insurance for your needs and tax situation.