Once retired, you'll also be drawing non-discretionary income from Social Security and taking required distributions from taxable retirement funds. As income from Social Security fills your lower income tax brackets, you can better minimize taxes by drawing income that you need from the cash value in your life insurance policy, generally tax-free. However, this will also lower the amount of the life insurance benefit once the policy owner dies.

If you have a substantial income such as interest, dividends, and other taxable income that must be reported on your tax return in addition to your Social Security benefits, you'll be subject to federal income taxes on 85% of your benefits. The fact is, most all taxable income, including tax-free municipal bond interest, is taken into account when determining just how much of your Social Security benefits the IRS will take. With permanent life insurance, the assets inside your policy won't increase the tax on your Social Security income.

Section 7702 of the U.S. IRS tax code was created to differentiate between life insurance policies and investment vehicles imitating life insurance contracts.