The Myth of Tax-Free Retirement Planning

A carpenter will use a screwdriver to drive a screw and a hammer to hammer a nail.  Those tools were designed to do specific things.  The carpenter uses the right tool for the job.

As you are planning for your future, use the right financial “tools.”

Annuities are the  products insurance agents should be advising for accumulating wealth for retirement.  If your insurance agent is trying to convince you to save for retirement with cash value life insurance because of its tax advantages, find another insurance agent with whom to work.

Life insurance cannot be beaten by any other product if your goal is to give cash to someone when you die.  If, however, your goal is to give yourself cash during retirement, there are other products that do a better job.


Tim BarnesLife insurance was the first product I learned when I started in insurance in 1987.  At that time I did not know any better than to listen to my agency manager.  The office I was in was getting national recognition for the number and face amounts of life insurance that we were selling.  “Just let them sell” was the famous quote from our area vice-president.  It was not until later that I learned that I was being trained to operate a scam.

We were being trained to offer life insurance as an alternative to more traditional types of retirement investment vehicles.  At that time there was no limit on the amount of money that one could shelter from the Internal Revenue Service inside a Universal Life insurance policy.  The Modified Endowment Laws passed by congress plugged that hole.

We were taught to tell people that they could transfer their entire 401k savings into a life insurance policy.  The unique tax advantages of life insurance would provide a retirement completely free of income tax.

We were to emphasize the “tax-free” benefits of life insurance and only mention the requirement that the policy result in a death benefit if we were asked.

Fortunately, I was transferred to a training position in another state before the law suits started flying.

Last week I saw a headline that made my skin crawl.  It was “Tax Free Retirement Plans.”   It brought back memories of the flood of law suits over Universal Life insurance in the late 80s and early 90s.

Today, I do not advise my clients on methods to accumulate wealth for retirement.  I work with them to help them keep what they have.  There are other professionals who are more qualified to work with people who are looking to invest and save.

I want to address the myth of tax-free retirement plans in today’s post.  There are still some mis-understandings.  Life insurance is life insurance.  It is not a retirement plan.


I want to start out with a disclaimer.  I am not a tax professional.  I am an Insurance Counselor.  Lawyers, Tax Accountants and the IRS are the only professionals that you can trust to give credible tax guidance.

Unless a licensed insurance agent is willing to stand next to you during an IRS audit, you can trust him to know what to do during underwriting of an insurance policy.  Don’t trust him to give you guidance on tax issues.

If you are looking for tax guidance, use the appropriate professional.


It is true that life insurance enjoys some special tax breaks.  What is often not mentioned is that those breaks are because of what life insurance does.  It fulfills a financial promise to someone else when the insured dies.  I repeat; in order to get the full tax benefits offered, a death must occur.

Everything hinges on a legal promise an insured makes to someone else.  They promise that when they reach age 100 they will give them a specified amount of money.

If they do not have the full amount of money they promise, they are free to use a bank’s savings account to make periodic deposits to save up the money.  This will allow them to save up the money to give when they are 100.

A problem arises, however, if they die between the time they make the promise and their 100th birthday.  The person who was made the promise will only get the balance that is left in the account after probate.  Depending on when the one making the promise dies and how much debt he had, the one who was promised the money is going to get much less that what was promised.  (Are you confused yet?)

Life insurance is different.  It is self-fulfilling.  If an individual who has made such a promise elects to use a life insurance policy to save for his promise, he can be assured that the person he promised money to will get the full amount of money if he dies before he reaches his 100th birthday.

Life insurance has two parts.  The cash value is the amount of money that has been accumulated towards the promise (Face Amount).  If the one who made the promise dies prior to reaching their 100th birthday, the insurance company promises fulfill the original promise.  It will give the beneficiary both the balance in the account (cash value) and enough to fulfill the promise (amount at risk).


Many life insurance agents emphasize the tax benefits of cash value Life Insurance.  Often they mis-lead people.  They point out the tax advantages but fail to mention the limitations.

Advantage 1 = Tax Deferral

Since the money in the cash value is ear-marked to be paid by someone who is over 100 years old or dead, it gets special tax treatment.  As long as it remains tied to a life insurance policy, it is not taxed.

Advantage 2 = Tax Free Access

One of the nice things about life insurance is that it is flexible.  If an emergency arises, money can be taken from the policy on a tax-free basis.

In Universal Life insurance, the policy owner may withdraw up to the amount that he put into the policy (basis) with no tax consequence.  After that, he must do the same thing that a person with a Whole Life insurance policy must do in order to access the cash value.  He must take out a “loan” against the policy’s cash value.

Many insurance agents say that the loan never has to be paid back.  This is a little misleading for two reasons.

  • Interest Payments

Whether you borrow money from the bank or your cash value life insurance, a legal debt is created.  The difference is in how you elect to pay off the debt.

If you borrow money from the bank, you will have to make payments during your lifetime.  The debt will continue until you have repaid the amount you borrowed plus interest.

If you borrow money from the insurance company, you are not legally required to make payments during your lifetime.  Just remember that you borrowed against a future promise.  When you die, the promised payment to someone else will be reduced by the amount you borrowed plus the interest that has accrued until the day you die

  • Death Benefit

Since the amount you borrowed is tied to a tax-free payment to be made to someone in the future, enough money must be left in the policy so that it will result in at least $ 1 in death benefit when the insured dies in the future.

If the policy does not result in a death benefit, all the growth experienced over the years will be taxable income in the year the policy lapses.

Recently, I was consulted by a man in his 80s.  He had purchased a whole life insurance policy during his 40s.  During his 70s he was persuaded to borrow most of his cash value.  Last year he canceled the policy.  This year he has to pay taxes on money he spent 15 years ago.

His life savings are gone.  To add insult to injury, he now has to pay the IRS an extra $ 15,000.


Don’t misunderstand what I am saying.  Life insurance is a wonderful tool.  My point is that you should use it for the purpose it was intended.  It was not designed to be a retirement plan.  It was designed to provide money to your loved ones when you die.


2 thoughts on “The Myth of Tax-Free Retirement Planning

  1. You do realize some people buy a min death benefit max cash value for the tax free advantage itself. I have accountants referring business to their clients for that reason alone.

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