Life insurance policy holds risks as pension


February 20, 1994|By JANE BRYANT QUINN | JANE BRYANT QUINN,Washington Post Writers Group

NEW YORK -- If you need a retirement investment, should it be a life insurance policy -- even if you don't need the insurance?

Cash-value life insurance is being widely sold today as the best way of building up money for the future. It's often called a "private pension plan." The insurer pays interest or dividends on the cash that accumulates in your policy. Those payments build up tax-sheltered.

There are, as you might suspect, some risks to this plan that the agent may or may not explain. Four questions for you:

(1) Do you have a tax-deferred 401(k) plan at work, where your employer matches the money you invest? If so, take full advantage of the match. That's an investment deal no one can beat.

(2) Do you have a tax-deductible retirement plan without a company match, such as an Individual Retirement Account or a Keogh Plan? These accumulate much more money than comparable insurance plans do.

Money drawn out of IRAs and other retirement plans is subject to tax. If your bracket is 33 percent, you'd need to take out $746 to net $500 a month. By contrast, you can borrow $500 a month from your life-insurance values tax free.

On the other hand, it's risky to borrow more than 70 percent of your life-insurance savings, for reasons explained below. In my opinion, this tips the advantage to the straight retirement plan. Life insurance might beat a deferred annuity, however.

(3) Can you afford to put the maximum premium into the insurance policy, to build up the highest possible cash value? Without high cash values, this scheme can blow up in your face.

Take a $200,000 universal life policy for a 40-year-old man. If his objective is to quit paying premiums at age 65 and start withdrawing money from the policy to live on, he should invest the maximum allowed under the tax laws -- in this case, more than $3,000 a year, says Chris Kite of FIPSCO, a computer software company that serves the life-insurance industry. At current rates of interest, this particular buyer could then take around $11,600 annually from his policy, from age 65 to 80.

Some agents might quote you this same plan at a "bargain" $1,500 a year -- counting on high dividends to build your cash values up. But all this does is underfund your retirement goal, especially when interest rates drop. Result: You won't have the retirement income you expected or you may have to put up more money to keep the policy from lapsing.

(4) Do you understand the implication of the loans? Once you've XTC borrowed substantial amounts from a policy -- to provide yourself with a tax-free income -- you are locked into insurance coverage for life, says life insurance adviser Glenn Daily of New York City. If you drop your policy, or if it lapses, a good part of the money that you have borrowed will be treated as taxable income. The tax bill could be large -- perhaps more than you can afford to pay.

What's more, if you borrow too much, the policy may lapse, triggering a tax. Or you may be asked to repay some of the loans. To be on the safe side, Kite says, you should borrow no more than 70 percent of your cash value. By contrast, in a straight retirement plan, you could safely draw on your money beyond age 80.

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