This is a guest post by the ChamberofCommerce.com.
Once your small business is off the ground, you may want to start investing in your company’s future and set up a retirement plan for you and your employees.
While tax-advantaged retirement plans like the SEP IRA, pension, or 401(k) are all decent choices for retirement savings, they can also be complicated to set up and manage. Another alternative that gives a lot more flexibility is cash value life insurance.
The Basics of Cash Value Life Insurance
When you buy a permanent life insurance policy, one that lasts your entire life, it may offer something called cash value. This is money you can take out of the policy and spend while you’re alive. Only permanent policies provide cash value. Term policies never offer this feature. The insurance company will invest your cash value so it grows over time.
You’ll have a variety of investment options to choose for your money from depending on what type of policy you buy. Whole life insurance policies offer a fixed, guaranteed rate of return every year. If you want to invest in the stock market, you can use a variable or equity indexed life insurance policy.
Cash value life insurance offers several helpful tax advantages. As long as you keep your cash value in your policy, you don’t owe income taxes on the growth. This is the same tax-deferred growth you see in other retirement plans.
In addition, when you take money out of your policy as a loan, you also won’t owe income taxes; your gains are tax-free. The trick is as long as you keep your policy in force, eventually you’ll die and the policy will pay a death benefit. The death benefit will pay off your cash value loan and your heirs will receive the rest of the money also tax-free.
Fewer Contribution Restrictions
Another advantage of using life insurance as a retirement plan is it has fewer contribution restrictions. When you set up a SEP or pension, the government restricts how much you can put in per year based on your salary. This can be frustrating if you want to save more.
In addition, the government has rules mandating you make minimum contributions on behalf of your employees. This can put you in the position where you can’t save for your own retirement unless you’re also putting money aside for all your employees, not just the ones you want to reward. Life insurance doesn’t have these restrictions and lets you save for retirement more on your own terms.
Adds Life Insurance Protection
When you invest in cash value life insurance, you’re also getting a life insurance policy on top of your retirement plan. This kills two birds with one stone if you already need coverage. If you need coverage for yourself to protect your family, then buying an insurance policy on yourself makes sense. This can also work well with key man insurance. Say you have an employee that would be very hard to replace. You could set up a policy where the employee earns the cash value as a retirement benefit while your company would receive the death benefit if the employee dies.
Now there are disadvantages to using life insurance as a retirement plan. First off, since you’re buying life insurance, you actually need to qualify for a policy. If you are older or have health problems, this can be an issue.
Another problem with these policies is that part of your contributions goes towards paying for the life insurance coverage. This is great if you actually need life insurance, but is one extra cost and lowers your total return. Putting the same portfolio in a regular investment plan will outperform life insurance because of this extra cost.
However, if you are looking for tax-free growth in a plan with few restrictions, cash value life insurance can work quite well. Be sure to consider this plan along with your other options to make an informed decision.
Megan Totka is the Chief Editor for ChamberofCommerce.com. She specializes on the topic of small business tips and resources. ChamberofCommerce.com helps small businesses grow their business on the web and facilitates connectivity between local businesses and more than 7,000 Chambers of Commerce worldwide.
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