How permanent life insurance provides income protection

By David E. Appel

Market fluctuations impact retirement assets, sometimes costing clients thousands once they need to tap into their hard-earned savings. Rather than leaving success to the chance of a volatile market, we can provide safety net options so clients can live comfortably in retirement. One of those strategies is purchasing a permanent life insurance policy.

One of the greatest benefits of any life insurance plan is that, when funds are withdrawn in certain circumstances, those funds are exempt from income tax. I encourage clients to apply for life insurance policies early on in their careers to reap the most benefits possible, drawing similarities to their retirement savings.

A retirement savings account differs from a permanent life insurance policy in that, regardless of market conditions, it is less detrimental to make withdrawals from the insurance policy. There are a few different ways these policy funds can be accessed:

1. Withdraw from the Cost Basis: For a life insurance policy, the cost basis is the amount of cash the policy holder has invested through premiums. With most permanent life insurance, the policy holder can withdraw from this cost basis. For example, if your client has invested $50k into a $100k policy, they would have a $50k cost basis to pull from. While this will reduce the benefit upon death, the money withdrawn is tax-free as it is considered a return of cash value invested.

2. Take Out a Loan: A unique aspect of permanent life insurance is the ability to take a loan out against the policy. The client can take a loan out based on its cash value. Based on the previous example, the client could take a majority of the $50k in cash value out as a loan. Interest will accrue when borrowing from the policy, which could be a variable or fixed rate depending on the policy. The client should continue to pay the premium as normal to avoid a loss in coverage, as well as refraining from borrowing more than the cash value of the policy. Once there has been enough cash value built over time through premiums, this can be a way to supplement the revenue stream during down markets.

3. Surrender the Policy: Some dire situations require clients to get as much money as they can as quickly as possible. In these cases, it is possible to surrender a permanent life insurance policy, allowing the client to receive the net surrender value. What’s important to remember is that any funds withdrawn beyond the cost basis invested will face income taxation. If the client were to receive $80k in the net surrender from our previous example, the first $50k will not be taxed as it is the cost basis while the remaining $30k would be taxed. Remind the client that there will also be a fee to surrender the policy, reducing their return.

Whichever option your client is interested in pursuing, keep in mind the earlier they begin paying into the policy the more cash value that accrues over time. The policy can then provide supplemental income in retirement during down markets.

Additional benefits of permanent life insurance

While retirement assets can diminish in a down market, life insurance policies will remain consistent regardless of market status. Clients can leverage this additional capital from the policy to focus on building retirement funds instead of draining them sooner than expected. However, this income protection can go beyond directly withdrawing funds from the plan.

I had a client a few years back who was looking to establish a permanent life policy. As we were executing the policy, I noticed the opportunity for a Long-Term Care (LTC) policy rider to accompany the policy, but we decided that would not be necessary. To our surprise, the client was in an accident and needed at-home care not long after the policy went into effect. I never would have thought a 43-year-old would need that kind of care. Since then, I always suggest adding an LTC rider to the policy if the client qualifies.

An LTC rider included as part of the life insurance policy adapts the policy to leverage the death benefit to cover costs for at-home health care, long term care facility or nursing home. This can be an important safety net should someone no longer be able to earn income through work and need extended medical care.

While this does not cover things like doctor visits or hospitalization, it will allow for peace of mind in the event of tragedy. As an advisor, you can check the availability of this policy with the policy provider and determine the percentage LTC benefit. For example: if the policy has a 4% LTC benefit on a $500K policy, the policy holder would be able to access $20K per month for LTC coverage.

Income protection is still a vital part of the financial plan, even in retirement. While the income may come from a different source, safety net options are integral to financial security for your clients. A permanent life insurance policy can serve as this backup option. The flexibility to either take a loan out on the policy or pull from the cash value makes a permanent life policy valuable to almost any client.

As with any investment, ensure your client understands the risks involved and gets started early. Educating the client through the ins and outs of the policy will help them trust your guidance and remain with your firm.

About the Author
David E. Appel, CLU, ChFC, AEP® is the Managing Partner of Appel Insurance Advisors in Newton, MA, and a 27-year MDRT member. David has been in the life insurance industry since 1992 and specializes in what his boutique firm has trademarked People Insurance™, life, health, disability, and long-term care insurance, for personal as well as corporate clients. David has earned multiple Court of the Table and Top of the Table honors through his MDRT membership.