Life insurance is a fantastic way to ensure that your family or business is taken care of in case of your untimely demise. Many folks also use it as an investment vehicle, taking advantage of the cash value of their policies and federal regulations making life insurance policy investment earnings tax-deferred.
While life insurance can be used as an investment vehicle, it may not be the best investment vehicle out there. There are a number of other investment options out there that have favorable tax circumstances and that may also provide better returns on investment than your life insurance policy. To choose which option is best for you, you need to understand your life insurance policy, and also understand the other options available.
Life insurance can be good investment vehicle under the right circumstances. Life insurance policies are used as investment vehicles primarily by those who want to take advantage of the tax-deferred status on earnings on the cash value of the policy made through investment. For folks taht have a high tax bracket and need an tax-deferred place to park their money and watch it grow, using life insurance as an investment vehicles is a fairly sound strategy. And there is one circumstance when a life insurance policy is a great way to invest. The downer is that you have to die for your beneficiaries to reap this benefit. If you die while the policy is in force, your heirs will collect the benefits of the policy tax-free, and they can also have any cash value you’ve built up in the policy.
Folks should be aware, however, that many life insurance policies contain fees and service charges related to this type of investment that may reduce the value of their earnings. Insureds should check their policies carefully and ensure that they know everything about the fees and commissions associated with their policy before they use it as an investment vehicle to save for retirement.
If you’re looking for other investment options, consider the following:
401 (k) plans — A 401 (k) plan may be a better option, especially if your employer sponsors a matching program where the employer puts in the same amount you put in, essentially doubling your investment. 401 (k) plans are tax-deferred, meaning that the income you put into the plan is not taxed. For example, if you earn $40,000 per year and contributed $3,000 to your 401 (k) plan, your taxable income for the year only would be $37,000, instead of the whole $40,000.
When the time comes for you to withdraw the money for retirement, there are no fees and commissions like the ones associated with life insurance policies.
Keogh plan — A Keogh plan is a pension plan for self-employed individuals. In a Keogh plan, you can contributed up to 20 percent of your annual income, or $49,000, whichever is lesser to the plan. The contribution is tax deductible. In the Keogh plan, you can start withdrawing funds at age 59 and a half, and must start withdrawing funds by age 70. The Keogh plan was established in 1962 as a means for self-employed individuals to save for their retirement. There are a lot of administrative burdens and upkeep costs associated with the plan, but it remains popular because of the high contribution limits.
IRA — An IRA is an investment tool that you can use to set aside money for retirement. Contributions to your IRA are tax deductible up to a certain point. When you withdraw the money, you’ll be assessed taxes on that income. This may be advantageous because your income is likely to be lower after you retire, meaning you’ll pay less money in taxes then.
Roth IRA — The Roth IRA is a retirement plan that is similar to the IRA, but does not allow tax deductions for contributions. Instead, distributions are exempt from taxes. However, if you withdraw funds from the plan before you are eligible to do so, you will incur a tax penalty. Qualified withdrawals include those taken after age 59.5 or after one becomes disabled, those taken to purchase a first home, or the withdrawal of a deceased plan member’s funds by a beneficiary. Depending on your income and investment strategy, getting your tax deferral on the distribution side rather than the contribution side may be more advantageous.
Before purchasing life insurance or investing in any other retirement savings plan, it’s best to consult with a financial planner you can trust. It’s also helpful to know how much income you’re likely to make in the future, and to have a savings blueprint for your retirement. With good information and good planning, your financial advisor can guide you toward making the correct decision regarding your retirement.