There’s a trick among financial advisors that’s rarely discussed, and it can reduce the tax you pay on 401(k) distributions after retirement. It’s called variable life insurance.
Discover More: 7 Tax Loopholes the Rich Use To Pay Less and Build More Wealth
Find Out: Here’s the Minimum Salary Required To Be Considered Upper Class in 2025
Created as a way to tie the long-term investments of premium payments to a market interest rate, these policies serve as a great investment, insurance policy and tax break for the right investor.
Variable life insurance tax benefits are essentially an IRS loophole of section 7702 of the tax code. This allows you to put cash (after-tax money) into a policy that is invested in the stock market or bonds and grows tax-deferred.
The insurance policies provide a death benefit to a beneficiary but also take part of your premium and invest it in the stock market and/or bond funds for long periods of time. While that money is invested, you can switch in and out of investment subaccounts tax-free. In a regular investment account, this is not allowed.
The thought is that you will hold the policy for 10-20 years, and if you see strong subaccount performance, you can pay the same amount each month for your premium while watching your cash value and death benefit grow.
Once the cost of insurance is covered (after X amount of years, depending on your age, health and risks), the amount of your monthly premium can be reduced while your investments still grow.
Regardless of what happens in the market, and given you have paid your premiums, your death benefit will always remain 100% tax-free to the beneficiary upon your death.
The most beneficial element to the policyholder is tax-free retirement income. Investors need to be careful, though, as the amount you withdraw could determine whether or not there are tax implications.
As Fed Week stated, you can access a portion of your cash value without owing income tax. When you want the money in your policy’s cash value, you can take tax-free withdrawals until you reach the amount of money you’ve paid in premiums, Fed Week added.
For example, whereas the money in the variable life insurance policy is tax-free up to the premium amount, the money you withdraw from your 401(k) will be taxed. If you are taking $1,000 a month from your variable life insurance policy, then that is $1,000 fewer dollars you need to draw from your 401(k). Since there’s no way to know what the tax rates will be in the future, this could save you a considerable amount of money.
