Should life insurance be part of your retirement strategy?

Retirement planning is about more than saving money in a 401(k) or IRA. It also means preparing for market volatility, creating stable income streams, and ensuring your estate plan protects your assets and loved ones.

That’s why financial products like life insurance and annuities can play a role in retirement strategies. While both are insurance products, they serve different purposes. Life insurance can help protect your family and legacy — but certain types, like whole or universal life, can also provide tax-advantaged cash value you can access for supplemental income in retirement. Annuities, on the other hand, are designed to provide guaranteed lifetime income, helping you manage longevity risk and cover essential expenses.

“Life insurance is designed to protect (your family) if you die too soon. Annuities protect you from living too long,” says Julie Hall, a certified financial planner with Vision Capital Partners in Ann Arbor, Michigan.

Whether or not life insurance should be part of your retirement strategy depends on your goals. 

If you’re looking to build a flexible financial foundation, leave a legacy, or create another income bucket for retirement, life insurance may be worth considering. However, speaking with a certified financial professional is essential because these are complex financial products with long-term implications. They can help you evaluate your options and design a strategy that fits your unique retirement needs.

What role can life insurance play in retirement planning?

Life insurance provides financial protection for your loved ones if you die. It helps replace lost income, cover everyday expenses, and ensure your dependents can maintain their standard of living — even if you’re no longer there to provide for them. It also covers final expenses, such as burial costs, and provides income for surviving spouses and dependents. But it can also do much more than that by providing tax-advantaged cash value you can tap into for income, emergencies, or financial flexibility.

Life insurance can play several key roles in retirement planning, depending on the type of policy and your financial goals. Here’s a breakdown of how it can work for you while you’re alive:

• Supplement retirement income. Permanent life insurance policies, like whole or universal life, build cash value over time. You can borrow against or withdraw from this cash value tax-free, providing an additional source of income in retirement.
• Serve as a conservative savings vehicle. The cash value component grows at a guaranteed or stable rate, making it a low-risk way to diversify your retirement portfolio.
• Provide flexibility during market downturns. During years when your investment accounts are down, you can tap into your policy’s cash value instead of selling investments at a loss.
• Cover unexpected expenses. You can use your policy’s cash value to cover healthcare costs, long-term care, or other emergencies without dipping into your primary retirement savings.
  

Types of life insurance and how they fit into retirement

While all life insurance operates under the same basic premise – providing a death benefit when a policyholder dies – these plans can be structured differently. There are three main types of life insurance: term, whole and universal.

Term life

As its name suggests, term life insurance provides coverage for a specific period. These policies are typically used for income protection during working years. If a family’s main breadwinner should pass away, the death benefit from a term life policy can replace their income.

“Term insurance is great for a young couple starting a family,” McNamee says.

Term life is the least expensive form of insurance, and these policies do not accrue cash value. They will pay out a death benefit if a policyholder dies during the term, but there is no payment or return of premiums if the person outlives the term. Sometimes, insurers allow policyholders to convert a term life policy to whole life.

Because term life doesn’t build cash value and ends after a set period, it usually doesn’t play a direct role in retirement planning and should only be used to provide a death benefit to your loved ones if you die. However, some term life policies also include a conversion option, which allows policyholders to switch to a permanent life insurance policy without undergoing a medical exam. This feature can be valuable for those who want low-cost coverage now but may consider using life insurance as part of their retirement strategy later.

Whole life

Whole life policies are a type of permanent life insurance, and they are active for life as long as premiums are paid.

“When we’re talking about retirement planning, generally permanent life is what we’re talking most frequently about,” says Jessica H. McNamee, founder and wealth management advisor with Sirus Wealth Strategies near Columbus, Ohio

These policies build cash value that can be tapped into at any time to cover unexpected expenses or provide additional income in retirement. Cash value growth is guaranteed, and policyholders may receive dividends. Premiums for whole life policies are higher than those for term life policies.

Universal life

Universal life is another type of permanent life insurance, but it’s structured differently from whole life. Premiums can be variable, and the cash value growth in these policies may be tied to the market.

There are a few different types of universal life insurance:

• Guaranteed universal offers lifelong coverage with predictable, level premiums and a guaranteed death benefit — but little to no cash value accumulation. It’s best suited for people who want affordable, permanent protection for their loved ones, but it doesn’t support retirement.
• Indexed universal has cash value growth tied to the performance of a market index, like the S&P 500, with a guaranteed minimum rate of return. This makes it a popular option for those seeking tax-advantaged growth potential and flexibility in retirement income, while still protecting against market losses.
• Variable universal allows you to invest the cash value in subaccounts similar to mutual funds. While they carry more risk, they also offer the potential for higher returns, making them a possible fit for experienced investors who want both life insurance protection and a more aggressive way to build retirement income.

The value of some policies can be susceptible to declines in market performance, so you should clearly understand the provisions of a universal policy before making a purchase.

Life insurance vs. annuities: Which one supports your retirement goals?

Unlike life insurance, which protects your loved ones after you’re gone, an annuity is designed to provide income while you’re still alive.

Certain life insurance policies can be a strategic part of your retirement plan, not just a safety net for your loved ones. Annuities, on the other hand, are built specifically for retirement income. In exchange for a lump sum or series of payments, annuities provide a guaranteed income stream, often for life. They’re especially appealing to retirees who want predictable income and protection against outliving their savings. However, it’s important to weigh the trade-offs, including fees, surrender charges, and limited liquidity.

Here’s a quick look at how life insurance and annuities compare.

When life insurance makes sense in retirement

Using life insurance as a retirement strategy may not be appropriate for everyone, but there are some instances when it makes sense to maintain a policy.

• You have enough assets to trigger the estate tax and don’t want heirs to have to pull assets from the estate to cover the cost.
• You want to provide a tax-free inheritance to loved ones or a final gift to a favorite charity.
• Your surviving spouse or dependents will lose income after you die. This may happen if you have a pension without a survivor option.
• You want a low-risk asset that could provide funds in retirement.
• You have maxed out your other retirement savings options.

A permanent life insurance policy with cash value can minimize the need to pull money from other retirement savings during an economic downturn.

“When the market goes down, you can pull from life insurance,” McNamee says. “It’s another bucket we can leverage during retirement years.”

Since long-term care can be a substantial cost in retirement, people may want to look for a hybrid life/long-term care insurance policy. These policies will allow people to use their benefits for long-term care, and any unused portion will go to heirs as a death benefit.

If you already have a conventional life insurance policy, you may be able to convert it to a hybrid. “You can take that current policy you have and do a 1031 exchange into a hybrid policy,” Hall suggests.

When annuities are a better fit

If you’re more concerned about running out of money while you’re alive, an annuity is a better choice.

“Some people are more risk-averse and maybe Social Security only covers 50% of their fixed expenses,” Hall says.

In that case, they can use their savings to purchase an annuity that will make monthly payments to cover their remaining bills.

“It gives us the ability to create our own personal pension,” McNamee says.

Since annuity payments are guaranteed, they can provide more stability than relying on invested savings, which can fluctuate daily with the market.

Be aware that not all annuities are alike, and some will increase payments annually with inflation while others will not. What’s more, annuities can be structured to begin payments immediately or after a certain period of time. All these factors will impact how much an annuity costs and what your monthly payouts will be.

Annuity options for retirement income

If you’re supplementing your retirement strategy with an annuity, it’s important to know that not all annuities work the same way. Here’s a breakdown of the main types and how each one fits into a retirement plan:

Immediate annuities. With an immediate annuity, you hand over a lump sum and start receiving guaranteed income almost right away — usually within a month. It’s a good option if you’re retiring and want to create a personal pension.
The tradeoff? You give up access to the lump sum in exchange for a reliable paycheck.

Deferred annuities. These are designed for people who don’t need income immediately. Your money grows tax-deferred, and you start taking payments later, often years down the line.
The tradeoff? You’ll wait longer to receive income, but your money has more time to grow.

Fixed annuities. Fixed annuities offer steady, predictable payments, no matter what the market does. They’re great for risk-averse retirees who want to know exactly how much they’ll receive each month.
The tradeoff? The returns are generally lower than market-based investments.

Indexed annuities. These tie your earnings to the performance of a stock market index like the S&P 500, but with limits on both gains and losses. You get more growth potential than a fixed annuity, without the full risk of investing directly in the market.
The tradeoff? You won’t capture the full upside of market gains, and the rules can be complex.

Variable annuities: These offer the most growth potential because you choose how your money is invested, typically in mutual fund-like subaccounts. Your income will depend on how those investments perform.
The tradeoff? More risk. Your payments can fluctuate, and fees can be high, so they’re usually best for experienced investors comfortable with market ups and downs.

Can you have both life insurance and annuities in your retirement plan?

There is no reason to feel you must choose between life insurance and an annuity. They serve two different purposes, and you can own both. In fact, many high-net-worth individuals do.

Life insurance can play a strategic role in retirement by providing tax-advantaged cash value that can be accessed for supplemental income, as well as offering long-term protection for your loved ones and your estate. Meanwhile, annuities offer guaranteed income for life.

Everyone’s retirement plan is unique, and finding the right mix of tools — including insurance and income products — depends on your goals, assets, and risk tolerance. Because this is a complex financial topic with long-term consequences, it’s important to speak with a certified financial professional. They can help you fully understand your options and build a strategy that fits your needs.

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