How to Use Whole Life Insurance for Tax-Free Retirement Income

Who benefits from a whole life insurance policy?

Alan, many whole life policies sold three decades ago haven’t matched the expectations set at the time of purchase. Interest rates and the broader financial environment were very different back then, so outcomes may diverge from original illustrations. Before suggesting specific actions, I want to address two points you raised: bank lending against policies and whether the original agent continues to profit more than you do.

Your agent earned commissions when the policy was sold. Using a modern pricing example: a 35-year-old male buying a $100,000 whole life policy might pay about $143 per month. In that scenario, the selling agent’s commission could be roughly $2,401 in the first year, about $86 in each of the next two years, and around $34 per year thereafter while the policy remains in force. At that ongoing $34 annual commission, the agent is unlikely to be extracting substantial value from your policy today.

One quirk of the industry is that the original selling agent often continues to receive those small ongoing commissions even if you transfer servicing to a new advisor. A new agent can request that the original agent assign the future commission payments, but that transfer doesn’t always happen.

Should you surrender (cash out) your policy?

When policy owners feel unsupported by their agent or insurer, surrendering the policy is a common option. Cancelling a policy—also called a lapse or surrender—benefits insurers and remaining policyholders because the insurer no longer faces the future death benefit liability; those savings can be reflected in dividend scales for participating policies.

It’s important to understand how dividends and dividend scales are presented. Insurers sometimes highlight a “dividend scale interest rate,” which can be mistaken for a guaranteed return similar to an investment yield. But that is not a straightforward growth rate for your policy. Insurers typically explain that the dividend scale is influenced by many factors such as premiums paid, the insured’s age, and risk profile, so dividends are not identical to an investment return you can rely on like a bank account.

When your policy was created, interest rates were higher and the market environment different. If nothing had changed in the last 30 years, the policy might be closer to the original illustration. Because economic conditions shifted, the product’s performance has too. That happens with many financial products and tax strategies, which is why flexibility and regular review are essential in long-term planning.

Borrowing against the policy for tax-free retirement income

Contrary to what you’ve been told, banks and third-party lenders do lend against the cash value of life insurance policies. Like any secured loan, lenders will assess your ability to repay. For a retired business owner, lack of steady employment income may make underwriting harder than for someone with a salary. If your income now comes mainly from investments or the company, lenders may view your application differently than if you had regular employment income.

Borrowing against the policy can provide tax-free cash because a policy loan is generally not taxable as long as the policy remains in force. But “tax-free” is not the same as cost-free. Interest on a policy loan accumulates and reduces the net death benefit and the policy’s cash value over time. If you borrow to fund retirement needs, the interest cost and the reduced death benefit are important trade-offs to weigh.

If preserving the death benefit for your beneficiaries isn’t your priority, surrendering and taking the cash value after tax could be the right choice. But before making that permanent decision, consider several scenarios and run the numbers with a planner:

• Surrender the policy, take the cash value, and pay the tax.
• Take a loan against the policy to create tax-free retirement income and measure the impact of interest on the death benefit.
• Borrow against the policy to invest in opportunities where the interest is tax-deductible, potentially offsetting the cost of the loan.
• Donate the policy to a registered charity and claim applicable tax credits.
• Consider how changes in your personal life—such as a new partner—would affect your wishes for the policy.

Ask yourself whether having a tax-free death benefit as a financial backstop gives you freedom to spend more now, draw on home equity, or be less worried about long-term care costs because the estate will eventually receive replacement funds. Your attitude toward that backstop should guide your decision.

Seek appropriate professional advice

Whole life insurance mixes guarantees, tax considerations, and flexible options, so it’s worth consulting a qualified financial planner before cancelling a long-standing policy—especially one you purchased at a young age and have paid for over many years. A planner can help model the outcomes for the choices above and show how the policy fits into a broader retirement and estate plan.

Further reading about life insurance

• Do I really need life insurance?
• Should seniors cancel their life insurance policies?
• Borrowing from life insurance: is infinite banking right for you?
• Using life insurance to cover taxes payable at death