Converting Your Insurance Policy to a Roth IRA at Retirement

It should come as no surprise that I hate life insurance in retirement. Unless, you are a business owner, have a large taxable estate (unlikely now a days), or have a special needs child, life insurance is just not necessary in retirement. Yet, one of the most popular questions I get is, “What do I do with this whole life insurance policy when I retire?”  This article discusses how you can get the most out of your life insurance policy by actually cancelling your policy.

Let’s discuss a common situation I see when a couple is approaching retirement. They have an old life insurance policy which they are paying on monthly, and trying to decide what to do. Do they continue to make the monthly premium and continue the life insurance in retirement? Or, do they cancel the policy and take the cash value? For whatever reason it always seems the cash values of these life insurance policies are like $10,000 to $20,000. Which seems like a decent deal, until you realize you have paid much, much more than this in premiums.

Most people don’t need life insurance in retirement

I’ve written before, that most people don’t need life insurance in retirement. Yes, there are special situations in which life insurance is important, but for most of us getting rid of life insurance is one of the first expenses to eliminate in retirement. Sure, I understand that you may want your spouse to be protected in retirement if something happens to you, but life insurance just doesn’t make sense for many people as you get older. Here is what I usually see happen.

First, many retirees will try to maintain making premium payments in retirement. They quickly realize that their payments go up because insurance gets more expensive as you get older. Therefore, the retiree stops making payments or keeps the same monthly payment, but money is then withdrawn from the cash value of the policy until there is no cash value left in the policy. Then, once the retiree is forced to make the payments again, they just cancel the policy as opposed to making further payments. The result, a lot of premium payments and nothing to show for it. I have a better solution.

A better solution to your whole life policy

Prior to retirement, cancel your life insurance policy and take out the cash value. Don’t go out and blow it on a new car, instead, if possible, make contributions into a Roth IRA. For 2018, you can make a full Roth IRA contributions if you are married and have earned income under $189,00.  If you are single, the income limit is $120,000. In 2018, you can contribute $6,500 if you are over age 50, and if you are married, you and your spouse can both make a Roth IRA contribution. In order to make Roth contributions, you do have to have “earned” income, which means that you have to be working.  You can’t contribute to a Roth IRA if you are retired and only have income from

Let’s compare cashing out your whole life insurance policy and contributing to a Roth IRA vs. keeping the life insurance policy.

For example, let’s say that you have a $100,000 life insurance policy that currently has $10,000 in cash value. If you cancel the policy and take out the $10,000 there may be a small tax liability, but it is only on any growth of your investment, which is typically very minimal. If you are married, and eligible to make Roth contributions, you and your spouse can split up the contributions, and you both can contribute $5,000 into a Roth IRA. If your investments earn 6% per year, your $10,000 investment will be worth $32,000 in 20 years, and worth $57,000 in 30 years. Now, that may not equal the $100,000 death benefit of the life insurance policy, but there are some major benefits of this strategy.

The benefits of a Roth IRA over a whole life policy

Like I mentioned before, life insurance gets very expensive as you get older.  $57,000 is certainly less than the $100,000 death benefit, but you don’t have to make yearly payments, you can use the funds yourself whenever you need it, and like the life insurance policy, it can be passed on to your beneficiaries tax free.  Also, if you pass the Roth account on to your beneficiaries, the Roth account will also grow tax-free throughout your kids lives as well. To me, I would rather have a little less death benefit, if I could stop making payments in retirement and have more flexibility with my money.  

I truly believe that life insurance is an expense that you can do away with in retirement.  If possible, turn that whole life policy into a Roth IRA. In order to do this, you still need to be working and earn less than the Roth contribution limit.  If you are retired and have no earned income, you won’t be able to take advantage of this strategy. When is $57,000 better than $100,000? When that $57,000 is a Roth IRA, and the $100,000 is a life insurance policy which you can’t touch and involves yearly contributions in retirement. Consider dumping the whole life policy and take the cash value and contribute to a Roth IRA at retirement.

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