Life Insurance: Building Wealth And Security

Life insurance is often thought of as a financial product that offers coverage to loved ones or beneficiaries in the event of the policyholder's death. However, it can also be a valuable financial asset during the policyholder's life, offering a way to build wealth. Some life insurance policies, particularly permanent life insurance policies, can accumulate cash value, which can be used as part of an overall investment strategy. This cash value can be accessed through policy loans or withdrawals and used for various purposes, such as supplementing retirement income or funding educational expenses. The growth of cash value within a permanent life insurance policy is typically tax-deferred, meaning taxes are only owed when the money is withdrawn. Additionally, the death benefit paid out to beneficiaries is usually income tax-free.

Cash value accumulation

Here's how cash value accumulation works in life insurance:

How Cash Value Accumulation Works

Types of Cash Value Accumulation

There are different types of life insurance policies that offer cash value accumulation, including:

• Whole Life Insurance: This is the most common type of permanent life insurance. It offers a fixed monthly premium, a fixed rate of growth for the cash value, and a guaranteed death benefit. Whole life insurance typically has higher premiums due to the cash value element.
• Universal Life Insurance: Universal life policies function similarly to whole life, allowing policyholders to grow an asset by accruing interest. However, premiums are not set and are subject to change.
• Variable Universal Life Insurance: This type of policy combines the premium and death benefit flexibility of universal life with the investment options of variable life insurance. Policyholders can invest their earnings into accounts of their choosing.

Accessing Cash Value

Policyholders have several options for accessing the cash value of their life insurance policy:

• Withdrawals: Policyholders can make partial or full withdrawals from the cash value. However, this will reduce the death benefit, and withdrawals above a certain amount may be subject to taxes.
• Loans: Policyholders can borrow against the cash value, using it as collateral for a loan. Interest rates apply, and if the loan is not repaid before the policyholder's death, the outstanding balance is deducted from the death benefit.
• Premium Payments: The cash value can be used to pay policy premiums, allowing policyholders to maintain coverage without additional out-of-pocket expenses.

Benefits of Cash Value Accumulation

• Long-term Wealth Building: Cash value accumulation can help build wealth over time, providing a separate asset class in a diversified financial portfolio.
• Tax Advantages: Cash value growth is tax-deferred, and loans or withdrawals may also have tax advantages.
• Flexible Access: Policyholders can access the cash value for various purposes, such as investing in other assets or supplementing retirement income.

Considerations and Limitations

There are also some considerations and limitations to keep in mind:

• Higher Costs: Cash value policies typically have higher premiums than term life insurance due to the savings component.
• Slow Accumulation: Cash value accumulation can be slow, especially in the early years of the policy when a larger portion of premiums goes towards insurance costs and fees.
• Potential Tax Implications: Withdrawing more than the amount paid into the cash value may result in taxes on investment gains.
• Impact on Death Benefit: Withdrawals and loans from the cash value will reduce the death benefit for beneficiaries.

Business succession planning

Business owners who wish to see their businesses continue operating after they are no longer involved need to plan meticulously. When a business owner is putting together a succession plan in the event of their death, life insurance becomes a crucial component.

A well-structured business succession plan can ensure the smooth transition of ownership and help minimise potential disruptions to day-to-day operations. One of the most common business succession planning strategies is the "buy-sell agreement". This is when the remaining owner(s) or a third party agrees to buy the deceased owner's share of the business at a predetermined price from the deceased owner's estate or heirs.

Using Life Insurance to Fund a Buy-Sell Agreement

Life insurance can provide the funding necessary to buy out the deceased owner's share of the business. Without a buy-sell agreement and/or insurance policy in place, the continuation of the business could be at risk. In the absence of such an agreement, the remaining owner(s) may be forced to liquidate the business if the heirs are not interested in keeping it.

One of the main types of life insurance used to fund a buy-sell agreement is Whole Life Insurance. Whole Life Insurance can be kept in force for the life of the insured as long as the required premiums are paid. It offers guarantees regarding the premiums, the cash value and the death benefit. Whole life policies typically guarantee a level premium at the outset. Assuming the premiums are paid in full and on time, the cash value of a whole life policy will grow at a guaranteed pace as stated in the contract. The death benefit is also guaranteed as long as premiums are paid as scheduled.

Some whole life policies also pay dividends when issued by a mutual insurance company and are considered participating policies. When the insurance company pays dividends to its whole life policies, both the cash value and the death benefit have the potential to increase.

Whole life insurance as an investment tool

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 a financial asset that can be used during your lifetime, just like an IRA or mutual fund. It offers a death benefit and a savings-style cash value account with a guaranteed rate of return. The cash value component is where its potential as an investment tool becomes apparent.

How it Works as an Investment

Whole life insurance provides permanent coverage that accumulates a cash value. When you pay your premium, the insurer invests a portion to give your policy a cash value. The cash value grows over time at a fixed rate guaranteed by your insurer. It’s tax-deferred, which means that any interest you earn isn’t taxed as long as you keep the funds in the policy.

Once you’ve accumulated enough cash value, you can take out loans against your policy. While you don’t need to pay back these loans, your insurer will subtract any outstanding amount from the payout when you die. To avoid issues later on, it’s important not to borrow too much against your policy.

If you buy a policy from a mutual life insurance company, you might receive dividends based on the company’s financial performance, which you can use to boost the face value of your policy.

Whole life insurance can be a good investment in certain situations:

• Maxed-out retirement accounts: If you’ve maxed out your tax-advantaged accounts, whole life insurance can be used to top up your tax-deferred savings.
• Lifelong dependents: Whole life insurance offers lifelong coverage, making it suitable for those with lifelong dependents, such as a child with a disability.
• Estate taxes: The cash value component of whole life insurance can help your loved ones pay estate taxes without dipping into other accounts.
• Diversification: The cash value grows at a set rate and is not subject to market volatility, so you won’t lose money if the market takes a downturn.

Drawbacks

Despite its benefits, whole life insurance is not suitable for everyone:

• Expensive premiums: Whole life insurance premiums tend to be much higher than term life insurance.
• Slow growth: It can take 10-15 years or longer for the cash value to build up enough to borrow against.
• Low rate of return: The average annual rate of return is 1-3.5%, which may be lower than other investments.
• Lack of control: The insurance company declares the dividend or interest rate and manages the investments, so you can’t control your portfolio.
• Tax implications: Withdrawing more than your policy basis may result in tax liabilities.

Using life insurance to create generational wealth

Life insurance is often viewed as a financial product that offers coverage to loved ones or beneficiaries in the event of the policyholder's death. However, it can also be a valuable tool for creating generational wealth and building a financial legacy. Here are some ways life insurance can be used to achieve this:

Permanent Life Insurance:

The two basic forms of life insurance are permanent and term. Permanent life insurance offers the potential for building cash value over time, making it a useful tool for creating generational wealth. Within the permanent category, there are several types of policies, including whole life, universal life, variable life, and variable universal life. These policies allow the policyholder to accumulate a cash value that can grow over time, providing a source of funds that can be passed on to future generations.

Tax-Deferred Growth:

The growth of cash value within a permanent life insurance policy is typically tax-deferred. This means that policyholders can accumulate wealth without paying taxes on the accumulated cash value until they withdraw it. This feature makes life insurance an attractive option for those looking to maximize their after-tax investment returns and pass on a larger sum to their beneficiaries.

Death Benefit:

The death benefit from a life insurance policy can provide liquidity to your estate, ensuring that your loved ones have the necessary funds to pay estate taxes, settle debts, or cover other financial obligations. By incorporating life insurance into your estate plan, you can efficiently preserve and transfer wealth to future generations. The death benefit is usually income tax-free for beneficiaries, allowing them to receive the full amount.

Business Succession Planning:

Life insurance can also play a crucial role in business succession planning. It can provide funds to facilitate a smooth transition of ownership in the event of the policyholder's death. The proceeds from a life insurance policy can be used to buy out a deceased partner's share, ensuring the continuity of the business and protecting its value for future generations.

Charitable Donations:

Another way to create generational wealth through life insurance is by naming a charitable organization as the beneficiary of the policy. This approach allows you to build wealth for philanthropic purposes while also reaping tax benefits during your lifetime. By doing so, you can leave a lasting impact on causes that are important to you and your family.

Whole Life Insurance as an Investment:

Whole life insurance, the most common type of permanent life insurance, offers a death benefit and a savings-style cash value account with a guaranteed rate of return. This makes it a stable and predictable option for those looking to create generational wealth. The cash value can be accessed through policy loans or withdrawals, providing flexibility in how the funds are utilized.

In conclusion, life insurance can be a powerful tool for creating generational wealth. By carefully selecting the right type of policy, taking advantage of tax-deferred growth, and incorporating it into your estate and financial plans, you can ensure that your loved ones will have the financial resources they need to carry on your legacy for generations to come.

Life insurance as a financial asset

Life insurance is often thought of as a financial product offering coverage to loved ones or beneficiaries in the event of the policyholder's death. However, it can also be a financial asset during one's lifetime. Certain life insurance policies can become a financial asset, much like an IRA or mutual fund, that allows the owner to build cash value over time and access this cash value.

Types of Life Insurance Policies that can be Used as an Asset

There are two main types of permanent life insurance that can be used as an asset: whole life insurance and universal life insurance.

Whole Life Insurance

Whole life insurance is the most common type of permanent life insurance. In addition to a death benefit, it offers the policyholder the ability to accumulate cash value. A portion of the premium paid every month is put into a cash value account, which accumulates over time at a minimum guaranteed rate indicated by the policy. The premiums on these policies typically remain fixed over the life of the policy.

Universal Life Insurance

Universal life insurance functions similarly to whole life insurance, allowing policyholders to grow an asset by accruing interest over time that can be borrowed against. However, the premiums are not set and are subject to change, and there is no guarantee on the rate the money will earn over time. Under the universal life insurance umbrella is variable universal life insurance, which enables policyholders to invest their earnings in the accounts of their choosing (including mutual funds), potentially earning more over time.

How to Use Life Insurance as an Asset

There are several ways to use life insurance as an asset:

• Take out a loan from the policy: It is possible to borrow against the cash value of a permanent life insurance policy. However, if there is an outstanding balance on the loan when the policyholder dies, it will be subtracted from what the beneficiaries inherit.
• Use the policy as collateral for a loan: In some cases, a life insurance policy can be used as collateral for a loan, making it easier to get approved or get a better rate. If the policyholder dies before paying back the loan, the outstanding balance will be deducted from the benefit received by the beneficiaries.
• Withdraw funds: Instead of taking out a loan, the policyholder can simply withdraw funds from the policy, which are theirs to keep. Withdrawing an amount that dips into investment gains will incur taxes. Withdrawing funds also decreases the value of the policy, reducing the benefit paid out to beneficiaries.
• Receive "accelerated" benefits: Some policies enable the policyholder to receive benefits during their lifetime if an unexpected or extreme medical emergency arises, such as cancer, a heart attack, or kidney failure.
• Surrender the policy (cash out): Surrendering a policy means cancelling the coverage and receiving the cash value put in, less any fees charged by the insurance company. Surrendering a policy may incur high fees and surcharges.

Benefits of Using Life Insurance as an Investment

Life insurance policies with a cash value component can be used as part of an overall investment strategy. The cash value of these policies grows tax-deferred, meaning taxes are not paid until the funds are withdrawn. Additionally, if the policy is set up correctly, beneficiaries typically receive the death benefit tax-free.

Risks of Using Life Insurance as an Investment

Using life insurance as an investment also carries risks:

• Fees: Policies may have high administrative fees and premiums, impacting the overall return. Surrendering a policy may also result in steep fees and surcharges.
• Low returns: The returns from permanent life insurance policies may be lower than other investment options. Life insurance policies generally have lower return rates than the stock market.
• Medical exam: Taking on a life insurance policy with an investment component usually requires a medical exam, which could increase the premium if it raises concerns for the insurer.

Frequently asked questions