Using life insurance for retirement income

You can draw retirement income from a permanent life insurance policy by withdrawing up to your premiums paid and then taking policy loans against the rest of the cash value. Done carefully, the income can be income-tax-free, because loans are generally not taxed while the policy stays in force. The strategy is expensive, depends on non-guaranteed assumptions, and fails badly if the policy lapses. It is a supplement for a narrow group of people, not a replacement for a 401(k) or IRA.

For how cash value builds in the first place, see whole life cash value: how it grows and how to use it. This guide covers using it in retirement.

How the income is drawn

The usual sequence has three phases:

1. Fund the policy for years. The owner pays premiums, often well above the minimum, into whole life with paid-up additions or into universal life (including indexed or variable). Cash value grows tax-deferred.
2. Withdraw basis. Under the general rules for a policy that is not a modified endowment contract, withdrawals come out of your cost basis (premiums paid, less dividends taken in cash and earlier withdrawals) first, tax-free. See withdrawing cash value from a life insurance policy.
3. Borrow the rest. A policy loan against cash value is generally not taxable income, because it is a loan and not a distribution. The loan accrues policy loan interest, and the balance is repaid from the death benefit at death.

If the policy stays in force until death, the loan comes off the death benefit and no income tax is due on the amounts borrowed. This is why the strategy is marketed as "tax-free retirement income." The weakness is the condition: the policy has to stay in force.

The rules that matter

Modified endowment contracts. If premiums paid in the first seven years exceed the seven-pay test limit, the policy becomes a modified endowment contracts and the 7-pay test (MEC). Loans and withdrawals from a MEC are taxed gains-first, and a 10% additional tax generally applies to taxable amounts taken before age 59 1/2. Heavy funding is exactly what retirement-income designs rely on, so the policy must be designed to stay under the limit. Ask your agent for written confirmation of the policy's non-MEC status and the maximum premium you can pay.

Section 7702. A policy must meet the definitions in section 7702 to keep its tax treatment. The Consolidated Appropriations Act, 2021 replaced fixed interest rates with market-based rates for policies issued after 2020. That limits how much cash value the tax code allows per dollar of death benefit.

Lapse with a loan. If the policy ends while a loan is outstanding, the loan is treated as a distribution. Anything above your basis becomes ordinary income in that year, possibly with no cash to pay the tax. This is the most serious risk. See how cash value is taxed: withdrawals, loans and surrenders and overloan protection riders: how they prevent a taxable lapse, which can help avoid it in some policies for a fee.

Social Security and Medicare. Loans are not income, so they are not counted in the taxable income used to determine Social Security benefit taxation, though a lapse-related gain would be. Check with a tax professional for Medicare premium surcharges, which use modified adjusted gross income.

Real costs and trade-offs

• Slow start. Early cash value is low because of acquisition costs and commissions. Retirement-income policies usually need 15 to 20 years of funding to work.
• Loan interest. The spread between the loan rate and what the borrowed cash value earns is your cost. A variable loan rate can rise.
• Non-guaranteed assumptions. Dividends, indexed crediting and cost-of-insurance charges can change. A sales illustration that shows decades of steady income uses assumptions the insurer is not obliged to meet. See guaranteed vs non-guaranteed values in a policy illustration and IUL illustrations and Actuarial Guideline 49.
• Limits are generous but different from retirement accounts. The 2026 employee deferral limit for a 401(k) is $24,500, and the IRA limit is $7,500 (IRS, November 2025). Those accounts provide a tax deduction or tax-free growth with far lower costs. Policy premiums are not deductible. Employer matches are not available in a policy.
• Death benefit reduction. Every loan reduces what your family receives.

A fair comparison asks what a low-cost index fund inside a Roth IRA or 401(k) would have produced with the same dollars. See IUL vs Roth IRA for tax-free retirement income and whole life as an investment: what the returns really are.

A hypothetical example

Say a 40-year-old pays $20,000 a year for 25 years into a policy, then takes $30,000 a year of income starting at 65 for 20 years. Say the first $500,000 of that income is basis and the remainder is loan. Everything depends on whether the policy's cash value keeps pace: if credited rates fall short of the illustration by even a point or two, the loan can outgrow the cash value in the later years and force a choice between repaying loans, cutting income or lapsing. This is an invented scenario to show the mechanism, not a projection.

Who it may suit

• People who have already maxed out 401(k), IRA and HSA contributions, still want more tax-advantaged savings, and need permanent insurance anyway.
• High earners with a lasting estate-planning need for a death benefit.
• Owners of an existing, well-funded, non-MEC policy that is paid up or near it.

Who should skip it

• Anyone who needs term coverage for a fixed period and has unfilled space in their workplace plan.
• People who might not keep paying for 15 or more years.
• Anyone who cannot explain the policy's loan rate, MEC status and lapse protection.

If retirement income is the main goal, compare with life insurance vs annuities: opposite tools for opposite risks, which converts savings to guaranteed lifetime income. See also life insurance in retirement: keep, cut or cash out for existing policies.

A checklist before you rely on policy income

1. Get a current in-force illustration on guaranteed and illustrated assumptions.
2. Ask for the loan rate, loan type and effect on dividends.
3. Confirm non-MEC status and monitor it if you add premiums.
4. Plan a maximum loan ratio and a backup income source.
5. Have a tax professional review a lapse scenario.

Key takeaways

• Retirement income from life insurance comes from withdrawals of basis followed by policy loans, which are generally tax-free while the policy stays in force.
• A MEC loses that treatment, and a lapse with a loan can create a tax bill with no cash to pay it.
• Costs, slow early growth and non-guaranteed assumptions make it a poor substitute for 401(k)s and IRAs.
• It can fit high earners with a lasting death-benefit need who have already used other accounts.
• Stress-test the plan on guaranteed values and keep a backup income source.