Life Insurance: A Smart Financial Leverage For Your Future

Life insurance is often purchased to provide financial security for loved ones after the policyholder's death. However, some life insurance policies can also serve as a financial asset during the policyholder's lifetime. Permanent life insurance policies, such as whole life and universal life insurance, allow policyholders to build cash value over time, which can be accessed in several ways. This cash value component offers a unique opportunity to leverage life insurance as an investment tool or savings account.

Policyholders can borrow against the cash value, make withdrawals, use it to pay premiums, or even surrender the policy for a lump-sum payment. Additionally, the cash value often accumulates tax-deferred, providing an added incentive for those seeking to maximise their investments.

Leveraged life insurance, also known as premium financing or enhanced funding, involves adding leverage to a permanent life insurance policy to accelerate cash value growth. This strategy utilises loans, with the cash value and death benefit serving as collateral. By contributing a larger premium, policyholders can benefit from the interest accrued on the overfunded value, which can offset the loan interest rate.

While life insurance is typically associated with death benefits, its potential as a financial tool during one's lifetime is an important aspect to consider when deciding on a policy.

Using life insurance as a financial asset

Life insurance is often thought of as a way to support your loved ones financially when you pass away. However, some life insurance policies can also be used as a financial asset during your lifetime. Permanent life insurance policies, such as whole life insurance and universal life insurance, are two types of policies that can be used as financial assets. These policies allow the owner to build cash value over time, which can be accessed in several ways.

One way to use your life insurance as a financial asset is to take out a loan from your policy. You can borrow against the cash value of your permanent life insurance policy, providing you with short-term liquidity. However, it is important to read the fine print, as the interest rate can be fixed or variable, and any outstanding balance at the time of your death will be subtracted from what your beneficiaries receive.

Another option is to use your life insurance policy as collateral for a loan. This can make it easier to get approved for a loan or get a better interest rate. Similar to taking out a loan against your policy, if you do not pay back the loan before your death, the amount you owe will be deducted from your beneficiaries' benefit.

You may also be able to withdraw funds from your life insurance policy. These withdrawals can provide you with income, and in some cases, may be tax-free if they do not dip into your investment gains. However, similar to the other options, withdrawing funds will reduce the value of your policy, and thus the amount your beneficiaries will receive.

In addition to these options, some life insurance policies offer "accelerated benefits," which allow you to receive benefits during your lifetime if you experience an unexpected or extreme medical emergency. Surrendering or cancelling your policy is another way to access the cash value, but it is important to consider the fees and taxes that may apply.

When shopping for a life insurance policy that can serve as a financial asset, it is important to look for policies that have a cash value. Permanent insurance policies typically fall under this category, whereas term insurance policies do not offer the ability to grow money in an account that you can access. Additionally, when considering the financial strength of the insurance company, choose an insurer with a high financial strength rating from credit rating agencies.

By understanding the features and options available with your life insurance policy, you can make informed decisions about how to use it as a financial asset during your lifetime.

Whole life insurance as an investment

Whole life insurance is a type of permanent life insurance that provides coverage for your whole life as long as you continue to pay your premiums. It is an investment tool and savings account that you can tap into while you are still alive. Here are some ways to use whole life insurance as an investment:

Withdraw or take a loan on the cash value

You can tap into the cash value of your whole life insurance policy to pay for major expenses such as college, a down payment on a house, an emergency fund, or retirement income. This is the most straightforward way to leverage your policy. You can choose to receive regular payments from the policy's cash value if you have accumulated a significant amount and no longer need the full death benefit. This income may be tax-free, as there is usually no tax liability on partial surrenders of non-modified endowment contracts until you have received all your premiums back.

You also have the option to take out a loan against a portion or all of the contract's cash value, which is used as collateral. However, you can choose to pay the loan back at your own pace or not at all. Keep in mind that not paying back the loan may cause your contract to lapse if you don't maintain a sufficient cash value, and it will also reduce your death benefit.

Create generational wealth

You can create an irrevocable life insurance trust (ILIT) to help your heirs navigate the federal estate tax, which can reduce their inheritance by up to 40% if your total taxable assets are larger than the filing threshold in the year of your death. Death benefit proceeds from a whole life insurance policy owned by an ILIT may pass to your heirs outside of your taxable estate, allowing them to create wealth for generations.

Collect dividends

Some whole life insurance contracts offer dividends, which is the money an insurance company distributes to eligible clients when it performs better financially than expected for the year. There are a few ways you can use these dividends to your advantage:

• Credit your dividend toward your premium to reduce out-of-pocket payments.
• Pay yourself directly with a check for the dividend amount.
• Credit the dividend to your life insurance contract to earn interest.
• Pay back any loans you've taken out against your contract.
• Purchase paid-up additional insurance (PUA) to increase your contract's cash value and death benefit.

Surrender the policy (but only if you no longer need it)

If you no longer need your whole life insurance policy, you can surrender it and receive the accumulated cash value, minus any fees and outstanding loan balances. However, keep in mind that surrendering your policy may create a taxable event, and you will also be giving up the death benefit attached to your life insurance.

When whole life insurance may not be a good investment

While whole life insurance offers many benefits, it is not suitable for everyone. Here are some instances where it may not be the best investment:

• If you only need a death benefit for a specific timeframe and are not interested in accumulating cash value, a term policy may be a better option.
• The cash value in whole life insurance can be modest and slow to grow, so if you are willing to take on more risk for potentially higher investment returns, traditional investments like mutual funds may be more appropriate.
• If you need to access the cash value sooner than anticipated, the cash value may be less than the premiums paid, resulting in a financial loss.
• The insurance company chooses where to invest the cash value portion of your policy. If you want to be more hands-on with the investment strategy, other options may be better.

Leveraged life insurance

Here's how it works:

You take out a permanent life insurance policy, such as an indexed universal life (IUL) policy, which offers a cash value component that grows over time. Instead of solely funding the policy with your own money, you borrow funds from a bank or lender to cover a significant portion of the premiums. This is where the "leverage" comes into play—you're using borrowed money to boost your investment.

For example, with the Kai-Zen strategy, you pay 25% of the premiums, and the bank contributes the remaining 75%. After a certain period (typically around) 15 years, the cash value of the policy has grown enough to repay the bank's contribution plus interest. At this point, you are left with a fully paid-up life insurance policy that you can utilize as you see fit.

The benefit of this approach is that it allows you to grow your cash value faster and generate higher returns than you would by solely relying on your own funds. The cash value component of permanent life insurance policies also offers tax advantages, as you can generally access and use the cash value tax-free.

However, it's important to carefully consider the risks and consult with financial professionals before pursuing a leveraged life insurance strategy. It's also crucial to ensure that you understand the specific mechanics and requirements of the policy, as well as any potential tax implications or consequences.

Life insurance loans

The cash value of a permanent life insurance policy typically starts accruing within two to five years, and it usually takes about ten years for it to build up enough to borrow against. The specific time frame depends on the type of policy and other factors. Insurers have different rules for the minimum amount of cash value required to borrow against a policy, and they also set limits on the percentage of cash value that can be borrowed, typically up to 90%.

The process of taking out a life insurance loan is straightforward and does not involve a credit check or income verification. You simply need to submit a form and verify your identity. The funds from the loan are then transferred to your bank account tax-free. There is also no requirement to specify the reason for the loan, and you can use the money for anything you want.

While life insurance loans offer flexible repayment schedules, it is important to understand the potential risks and downsides. If the loan is not repaid before the policyholder's death, the insurance company will deduct the amount owed, including any accumulated interest, from the death benefit paid to the beneficiaries. Additionally, if the loan amount and interest exceed the policy's cash value, the policy may lapse, and the outstanding balance may be treated as taxable income. Interest rates on life insurance loans are typically lower than those for personal loans or credit cards, ranging from 5% to 8%.

Life insurance as collateral

Life insurance can be used as collateral when applying for a loan. This is known as a collateral assignment of life insurance. It is a common requirement for business loans, as it guarantees repayment if the borrower dies or defaults.

The collateral assignment of life insurance allows you to specify the amount of your death benefit that your lender will receive if you pass away during the loan term. The death benefit is used as collateral for the loan. The lender becomes the assignee of the policy until the loan is repaid.

Both term and permanent life insurance policies may be used as collateral, although some lenders may not accept term life policies since they do not have a cash value. A permanent life insurance policy with a cash value is preferable as it provides an additional safeguard for the lender in case the borrower defaults on the loan.

The borrower must be the owner of the policy but does not have to be the insured person. The policy must remain current for the life of the loan, with the policy owner continuing to pay all premiums.

If you die before fully repaying the loan, the collateral assignment will allow the lender to be repaid for the outstanding loan amount using your death benefit. If you repay the loan fully before passing away, or if only a portion of your death benefit is needed to pay off the loan, your beneficiaries can still file a claim for the remaining death benefit.

Using life insurance as collateral for a loan can be a good alternative to using your house, car, or other assets as security. It can also help you secure funding to start a business or pay for major expenses. However, if you default on the loan, the lender will have the first claim to your policy's death benefit.

It is important to understand the potential drawbacks of using life insurance as collateral and to consult a financial advisor to ensure it is the right decision for your situation.

Frequently asked questions