Using Life Insurance to Build Wealth

When thinking about life insurance, the first thing that likely comes to mind is the cash payout your loved ones can receive when you pass away. However, some policies also allow you to build wealth during your lifetime by accumulating cash value you can tap into.

By understanding how these products work and the different ways you can use them, you can decide whether using life insurance to build wealth is right for you. Here’s what to know.

How Life Insurance Can Help Build Wealth

Life insurance comes in two basic categories: term and permanent. Term policies are typically less expensive, given the size of the death benefit they provide. While permanent life insurance policies can be more expensive, they have two advantages that term contracts don’t: They provide guaranteed coverage for life as long as you pay the required premiums. They also have a savings component that grows over time, allowing you to create long-term wealth.

Part of each premium you pay helps fund your policy’s cash value. In addition, the insurer pays interest at a fixed or variable rate, depending on your contract. As your cash value increases, you can tap into your policy for various needs, like retirement, a family member’s college education, or home repairs. Generally, money you pull from your life insurance contract isn’t taxed, as long as it doesn’t exceed the total amount of premiums you’ve paid into it.

Life Insurance Policies That Have Cash Value

Most permanent life insurance policies have a cash value component, although they work differently.

Whole Life

Whole life policies have level premiums for life and provide a minimum guaranteed interest rate. Some “participating” policies, which mutual companies offer, also provide a non-guaranteed dividend payment based on the insurer’s financial performance.

Universal Life

With universal life, you can adjust your premiums and coverage amount after you purchase the policy, providing greater flexibility. Unlike whole life products, the interest rate is variable.

Variable Life

Your return for variable life is based on the performance of investment subaccounts—similar to mutual funds—you select. This introduces the potential for greater returns than a whole life policy but also greater risk. Variable life policies typically cap your earnings in years when your subaccounts do well but also limit your potential losses during a market downturn.

Indexed Universal Life

As with variable life, the return on an indexed universal life policy isn’t guaranteed. Rather, the interest you receive is tied to an investment index, such as the S&P 500. You can change your premium payments, within certain limits.

Accessing Your Cash Value to Build Wealth

After your policy has been active for a certain number of years, you can access your cash value for a wide range of financial needs. In addition to assigning your life insurance as collateral for a loan, here are some ways you can tap into the wealth you’ve accumulated.

Make a Withdrawal

You can withdraw a portion of the cash value while keeping your policy active. Any withdrawals you make reduce the death benefit available to your beneficiaries.

Take Out a Policy Loan

Many life insurance policies allow you to take out a loan against your policy. You can repay the loan, with interest, to rebuild your cash value and the death benefit. Any unpaid loan amounts reduce the death benefit your beneficiaries receive upon your passing.

Pay Your Premiums

Rather than receiving cash, you can apply some of your cash value to your premium payments to leave some extra room in your budget. You have to be careful, though, as running your cash balance too low may cause your contract to lapse.

Surrender Your Policy

If you no longer need life insurance coverage, you can surrender (or cancel) your policy and receive the cash value. As a result, your beneficiaries won’t receive a death benefit when you die. Surrendering your policy within the first few years may result in fees, although they typically taper off each year you own the policy.

Your policy’s cash surrender value may be taxable if the amount you receive is more than the total amount of premiums you paid into the policy.

Considerations When Buying a Cash Value Policy

Your ability to afford permanent life insurance is one of the key factors to consider before purchasing a contract. Because these policies allow you to accumulate cash value—and provide lifetime coverage—they typically have higher premiums than term insurance with the same death benefit. To keep your coverage active, you must continue making those premiums until your policy is paid.

Additionally, a whole life or other permanent policy is best suited for long-term financial needs. It can take several years to build substantial cash value in your policy. And if you surrender your policy within a few years after buying it—in some cases, as many as fifteen years—you may incur fees that decrease the amount of cash you get back from the insurer.

Using Life Insurance for Estate Planning

Life is full of uncertainty. So even if you’re in good health now, you may want to consider how your passing could financially affect those closest to you. Life insurance can be a good way to ensure your spouse, children, or other loved ones are provided for, no matter what the future brings.

Distributing Wealth

Permanent life insurance policies with a cash value component can be particularly helpful if you have complex estate planning needs. For example, say you own a business that only one of your children will inherit and operate when you pass away. You can use your life insurance policy’s death benefit to ensure an equitable distribution of assets to your other children.

Managing Inheritance Taxes

If you have a large estate, life insurance can also help your family manage federal or state inheritance taxes. The insurance policy provides a liquid source of cash they can use to pay those taxes, without having to quickly sell off other assets at reduced prices.

Establishing an Irrevocable Life Insurance Trust

Another strategy for high-net-worth individuals is to establish an irrevocable life insurance trust (ILIT) that owns and becomes your policy’s beneficiary—though you can have the trust distribute the death benefit to any beneficiaries you select. In creating an ILIT, you can shield those assets from estate taxes, potentially allowing you to leave more of your wealth to your family members. Setting up an irrevocable trust can have drawbacks—namely, the inability to make future changes to your trust—so consult with an estate planning professional about whether this strategy is right for you.

Building Wealth for Future Generations

While there are many avenues for creating wealth that can be passed down to future generations, using life insurance to build wealth offers flexibility and opportunity. Contact a financial professional for a personalized look at your situation and goals.

During your research, it may also be worthwhile to consider guaranteed acceptance whole life insurance available through Colonial Penn. This type of policy allows you to protect your family and build wealth, no matter your health history. Reach out to a representative to learn more and get a free quote.

Insurers and their representatives are not permitted by law to offer tax or legal advice. The general and educational information here supports the sales, marketing or service of insurance policies. Based upon individuals’ particular circumstances and objectives, they should seek specific advice from their own qualified and duly-licensed independent tax or legal advisors.

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