A Roth IRA Alternative: Cash Value Life Insurance
Utilizing a permanent life insurance policy to supplement retirement income involves making premium payments with after-tax dollars. These premium payments serve two purposes: to cover the cost of the policy’s death benefit and to build up cash value in the policy. The policy’s cash value can be invested in various types of investments, depending on the type of product. One popular product invests the cash value into index options, such as the S&P 500 stock index. Typically, the investment options will include a floor so that if the index falls below the floor, the crediting rate remains at the floor (0% or even 1% or 2%). They also generally contain a cap. To the extent the index grows beyond the cap, only the amount up to the cap will be credited.
After allowing the cash value to grow for a number of years, the owner of the policy can borrow against the cash value to supplement retirement income. Such a withdrawal, since it is a loan, is tax-free so long as certain rules are met and the policy is not a modified endowment contract. Upon the owner’s death, policy loans will be repaid, reducing the death benefit that is payable to policy beneficiaries. Life insurance policies that are meant to provide supplemental retirement income should have contractually low-interest rates on borrowed funds.
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