Cash Value Life Insurance: A Tax-Free Income Strategy for High-Income Earners

Jarrett E. Hindrew, CFP®, ChFC®, CLU®, Financial Advisor
Creative Financial Group, a Division of Synovus Securities, Inc.

“The only difference between death and taxes is that death doesn’t get worse every time Congress meets.”— Will Rogers

This quote humorously captures the reality many retirees face: taxes can erode retirement income, especially when relying solely on qualified plans. Strategic use of life insurance can help mitigate this risk.

For high-income professionals, traditional retirement tools like 401(k)s and IRAs often fall short due to IRS-imposed limits. One powerful alternative is cash value life insurance, which can be structured to provide tax-free income in retirement – especially valuable for those affected by IRC Section 401(a)(17) and concerned about Medicare premium surcharges (IRMAA).

IRC Section 401(a)(17): A Hidden Limitation

IRC Section 401(a)(17) limits the amount of compensation that can be considered for qualified retirement plan contributions. For 2025, the cap is $350,000. This means:

• Executives earning above $350,000 cannot contribute or receive employer matches on income beyond that threshold.
• This restricts retirement savings potential for highly compensated employees (HCEs).

To bridge this gap, many turn to non-qualified strategies like cash value life insurance.

Cash Value Life Insurance: A Tax-Efficient Solution

Permanent life insurance policies – such as Whole Life, Universal Life, Variable Universal Life or Indexed Universal Life (IUL) – offer a cash value component that grows tax-deferred and can be accessed tax-free through policy loans and withdrawals.

• Tax-Free Income Strategy:
  • Withdrawals up to cost basis (total premiums paid) are tax-free.
  • Policy loans are not considered taxable income and do not trigger IRS reporting.
  • Properly structured policies avoid Modified Endowment Contract (MEC) status, preserving tax advantages.

Medicare IRMAA: Why Tax-Free Income Matters

Income-Related Monthly Adjustment Amount (IRMAA) is a surcharge added to Medicare Part B and Part D premiums for individuals with higher Modified Adjusted Gross Income (MAGI).

Qualified Plan Withdrawals Increase MAGI

• Distributions from 401(k)s, IRAs, and other qualified plans count as taxable income.
• Higher MAGI can push retirees into IRMAA brackets, increasing Medicare premiums by hundreds or even thousands annually.

Medicare Part B (Medical Insurance Costs)

In 2025, the base Medicare premiums for Part B and D are $185 and $36.78 per month, respectively. If your modified adjusted gross income as reported on your IRS tax return from two years ago is above the threshold, the additional income related monthly adjustment applies. Important Note: For married couples, IRMAA surcharges apply individually. If both spouses are Medicare-eligible and their joint income exceeds the threshold, each person pays the additional premium – potentially doubling the impact.

Medicare Part B Premiums Chart

Source: www.medicare.gov/publications/11579-medicare-costs.pdf

Medicare Part D Premiums Chart

Source: www.medicare.gov/publications/11579-medicare-costs.pdf

Cash Value Withdrawals Do Not Affect MAGI

• Loans from life insurance policies are not reported as income.
• This allows retirees to supplement income without triggering IRMAA surcharges.

Example: Strategic Retirement Income

A retired executive with $500,000 in a 401(k) and a well-funded IUL policy:

• Withdraws $40,000 from the 401(k): taxable, increases MAGI, potentially triggers IRMAA.
• Instead, borrows $40,000 from the IUL policy: tax-free, no impact on MAGI, no IRMAA.

Key Considerations

• Cost: Permanent policies are more expensive than term insurance.
• Loan Management: Unpaid loans reduce the death benefit and can cause policy lapse.
• Long-Term Planning: Requires disciplined funding and proper structuring.

Avoiding MEC Status: Why It Matters

A Modified Endowment Contract (MEC) occurs when a policy is overfunded too quickly, violating IRS guidelines. If a policy becomes a MEC:

• Withdrawals and loans become taxable.
• Distributions before age 59½ may incur a 10% penalty.
• The policy loses its tax-free income advantage.

To avoid MEC status:

• Work with a financial advisor to structure premium payments carefully.
• Use level funding strategies over time.
• Monitor policy performance and funding ratios.

Conclusion

For high-income earners constrained by 401(a)(17) and concerned about rising Medicare costs, cash value life insurance offers a flexible, tax-efficient retirement income strategy. It not only restores lost savings potential but also protects against IRMAA surcharges – making it a valuable tool in holistic financial planning.