Millionaires' Secret: Building Wealth With Life Insurance

Life insurance is a crucial form of protection for families, helping them to cushion the financial impact of losing a loved one. However, it can also be used as an effective strategy to build wealth. Permanent life insurance policies, which last an entire lifetime, can build cash value, allowing for tax-free withdrawals or loans while the policyholder is alive. This cash value grows at a guaranteed rate and is protected from stock market fluctuations. This makes permanent life insurance an attractive option for those looking to build wealth over time, as it provides a safer alternative to the volatility of stocks and bonds.

Permanent life insurance as an investment tool

Permanent life insurance, which includes whole life insurance and universal life insurance, can be used as an investment tool to accumulate wealth. Here are some of the benefits and drawbacks of using permanent life insurance as an investment strategy.

Benefits of Permanent Life Insurance as an Investment Tool:

• Tax-deferred growth: Permanent life insurance allows policyholders to invest on a tax-deferred basis, meaning they don't have to pay taxes on interest, dividends, or capital gains on the plan's cash value unless they withdraw the proceeds. This is similar to the tax benefits offered by certain retirement accounts like IRAs and 401(k)s.
• Lifetime coverage: Unlike term life insurance, which has a set coverage period, permanent life insurance covers the insured for their entire lifetime. This is beneficial if you anticipate people being financially dependent on you beyond the length of a typical term policy, such as in the case of a disabled child.
• Access to cash value: Policyholders can borrow against the cash value of their permanent life insurance policy without incurring penalties, which is not typically allowed in tax-advantaged retirement plans like 401(k)s. This provides flexibility in accessing funds when needed.
• Accelerated benefits: Insured individuals may be able to receive a portion of their policy's death benefit while still alive if they develop a critical illness, such as cancer or a heart attack. These funds can be used to pay for medical bills and other expenses.

Drawbacks of Permanent Life Insurance as an Investment Tool:

• Cost: Permanent life insurance policies often require higher premiums compared to term life coverage. The premiums tend to be much higher than term life insurance, making it a more expensive option.
• Slow cash value accumulation: In the early years of a permanent life insurance policy, a larger portion of the premium is allocated to administrative costs and commissions. As a result, cash value accumulation can be slow during the initial years, and it may take a decade or more to build up enough cash value to borrow against.
• Tax implications: There can be tax consequences if the beneficiaries surrender the coverage or if the insured dies with outstanding loans against the policy. Additionally, borrowing from the cash value or accessing accelerated benefits can reduce the eventual payout to beneficiaries.
• Low rate of return: The average annual rate of return on the cash value for whole life insurance is typically between 1% to 3.5%, which may be lower than potential returns from other investments like stocks, bonds, or real estate.

Tax-free savings

Life insurance is a crucial form of protection for your loved ones and can be used to build wealth. It can be used to pay off loans and debts, meet daily living expenses, and protect a family’s inheritance or a business.

Permanent life insurance, which does not expire, is one of the main ways to build wealth. It comes in two types: whole life and universal life. Both types combine a death benefit with a savings component, but there are differences. Whole life insurance policies offer coverage for the entire lifetime of the insured, and the savings grow at a guaranteed rate. Universal life insurance, on the other hand, has different premium structures, and earnings are based on market performance.

One of the main advantages of permanent life insurance is that it offers tax-deferred growth. This means that the policyholder can invest on a tax-deferred basis, and is exempt from paying taxes on interest, dividends, or capital gains on the plan’s cash value, unless they withdraw the proceeds. This is similar to the tax benefits offered by certain retirement accounts, such as IRAs, 401(k)s, and 403(b)s.

Permanent life insurance also offers access to cash value. Policyholders can borrow against the cash value of a permanent life insurance policy without incurring penalties, unlike in tax-advantaged retirement plans such as 401(k)s. This can be used to pay premiums, take out a loan at a lower rate than banks offer, or supplement retirement income.

Another benefit of permanent life insurance is that the death benefit is completely income-tax-free for beneficiaries. This is not true for most other financial accounts, such as individual retirement accounts (IRAs), tax-deferred annuities, and qualified retirement plans.

In addition, permanent life insurance can be used to save more if you have already contributed the maximum amount to your 401(k) and IRA in a given year. There are no restrictions on how much you can put into permanent life insurance, and no income restrictions, unlike a Roth IRA.

Finally, permanent life insurance can be used to create an income-tax-free inheritance for your loved ones. Within specified limits, you can make withdrawals as long as the policy is current. You can also borrow against the value of the policy without owing income tax.

Protecting a family business

Life insurance is a valuable tool for millionaires looking to protect their family businesses and ensure their legacy is preserved for future generations. Here are some key strategies on how millionaires can use life insurance to safeguard their family enterprises:

Key Person Insurance

Family businesses often rely heavily on the expertise, connections, and leadership of a few key individuals. To protect against the unexpected loss of a key contributor, millionaires can take out key person insurance. This type of life insurance policy helps the business survive the death of a crucial member by providing funds to hire and train a replacement, maintain operations during the transition, and cover any financial losses incurred during that period.

Shareholder Protection

In a family business, it's common for shares to be distributed among family members. If one of the shareholders passes away, their shares could be passed on to someone outside the family, creating conflict and instability. Shareholder protection insurance ensures that the remaining family members have the financial means to purchase these shares back from the deceased's estate, keeping control of the business within the family.

Business Loan Protection

Many businesses take out loans to fund expansion, manage cash flow, or invest in new opportunities. If a key person who signed or guaranteed the loan dies, the business may struggle to repay it. Business loan protection insurance provides the necessary funds to settle the outstanding debt, reducing the burden on the business and the surviving family members.

Estate Planning

Life insurance can also play a crucial role in estate planning for family businesses. By setting up an irrevocable life insurance trust (ILIT), millionaires can ensure that their businesses pass to their chosen heirs without the burden of hefty estate taxes. The ILIT owns the life insurance policy, and upon the death of the insured, the policy's death benefit is paid into the trust. This provides liquidity to pay any estate taxes due, ensuring the business assets don't have to be sold to meet tax obligations.

Succession Planning

Life insurance can facilitate a smooth transition of the family business to the next generation. By providing funds to buy out the interests of other family members, life insurance helps ensure that the business stays in the hands of those who are actively involved in its operations. This can prevent disputes among family members and ensure a fair distribution of wealth.

Estate planning

Life insurance is a crucial form of protection for families and can also be an effective strategy to build wealth. It can be used as an investment tool with tax benefits to maximise one's after-tax estate.

Tax-Free Accumulation:

Millionaires can take advantage of the tax benefits associated with life insurance. Permanent life insurance policies allow tax-deferred growth, meaning policyholders are exempt from paying taxes on interest, dividends, or capital gains on the policy's cash value unless they withdraw the proceeds. This enables the accumulation of wealth over time.

Lifetime Coverage:

Permanent life insurance provides lifetime coverage, ensuring that loved ones are financially protected for as long as the policyholder lives, as long as premiums are paid. This is especially beneficial for individuals who anticipate financial dependents beyond the length of a typical term policy, such as a disabled child.

Access to Cash Value:

Policyholders can borrow against the cash value of a permanent life insurance policy to meet various financial needs, such as supplementing retirement income or funding a new business venture, without incurring penalties. This provides liquidity and financial flexibility.

Estate Tax Protection:

Life insurance can help offset estate taxes, which can be as high as 40% for estates valued over a certain amount. A life insurance policy with a death benefit equal to or greater than the anticipated tax burden can preserve the wealth transferred to heirs.

Business Protection:

Life insurance can be used to protect a co-owned business. In the event of a partner's death, the surviving partner can use the life insurance death benefit to buy out the deceased partner's share, ensuring the business remains under their control.

Investment Portfolio Diversification:

The cash value of a whole life insurance contract does not fluctuate with market changes, providing a stable asset in an investment portfolio. This can be particularly useful during volatile market periods when accessing other assets may be undesirable.

By utilising these strategies, millionaires can effectively use life insurance for estate planning, maximising the wealth transferred to their heirs while also taking advantage of the tax benefits and financial flexibility that life insurance offers.

Long-term care

Life insurance can be used to fund long-term care, which may include assistance with daily activities like bathing, dressing, and eating, as well as community services and ongoing care in a nursing home or assisted living facility. Here are some ways to use life insurance for long-term care:

Combination (Life/Long-Term Care) Products

Some insurance companies now combine life insurance with long-term care insurance to address consumers' fears of wasting their investment if they do not use it. With these combination products, policy benefits will always be paid out in one form or another. The amount of the long-term care benefit is often expressed as a percentage of the life insurance benefit, and the features of these products are still evolving.

Accelerated Death Benefits (ADBs)

This feature, included in some life insurance policies, allows you to receive a tax-free advance on your life insurance death benefit while you are still alive. ADBs may be included at little or no cost, or you may need to pay an extra premium to add this feature. There are different types of ADBs, and depending on your policy, you may be able to receive a cash advance if you are terminally ill, have a life-threatening diagnosis, need long-term care services for an extended period, or are permanently confined to a nursing home. The amount of money received from ADBs varies, but typically, the accelerated benefit payment is capped at 50% of the death benefit. It's important to consider that using the ADB option may leave little or no death benefit for your survivors and could affect your eligibility for Medicaid.

Viatical Settlements

Viatical settlements allow you to sell your life insurance policy to a third party if you are terminally ill, receiving a percentage of the death benefit based on your life expectancy. The viatical company then becomes the policy's beneficiary and takes over premium payments. This option provides funds to pay for long-term care, but there will be no death benefit for your heirs. Additionally, viatical companies approve less than 50% of applicants, and the money received may be tax-free if you have a life expectancy of two years or less or are chronically ill.

Sell a Policy for a Life Settlement

With a life settlement, you can sell your life insurance policy to a third party for market value and use the proceeds to fund a long-term care benefit plan. Any type of life insurance can be used, but most companies require a minimum death benefit of $50,000. The shorter the life expectancy, the larger the percentage of the death benefit that will be paid to the insured. For example, a 90-year-old individual with a $100,000 death benefit could sell their policy and receive up to $60,000, which would then be managed by a licensed benefit management company to pay for long-term care.

Set Up a Living Benefit Program

A living benefit program provides a lump sum payment to those who meet specific medical criteria, allowing individuals to receive up to 50% of their life insurance policy's death benefit while still reserving some benefits for their family. For example, if an individual has $200,000 in coverage, they could secure up to a $100,000 living benefit to pay for senior care expenses. It's important to note that a living benefit is essentially a loan against the policy, and the entire loan, including interest, must be repaid; otherwise, it will be deducted from the death benefit.

Surrender the Life Insurance Policy for Cash Value

When a policy owner surrenders a life insurance policy, they give up ownership and the death benefit. If the policy has accumulated cash value, the insurance company will provide a check for the full amount of that cash value, which may be subject to taxes. It's important to consider the tax implications and any penalties for surrendering a policy early. Additionally, if the individual plans to use Medicaid to pay for long-term care, the cash value of their life insurance policy may count against them for eligibility.

Take a Loan from Cash Accumulation

Taking a loan from the cash value of a life insurance policy is another option, but it's important to note that taking the full amount could cause the policy to lapse. However, policyholders can usually take most of the cash value as a loan that they then pay back to themselves with interest.

Use Cash Value to Fund a New Long-Term Care Policy

If there is time to plan, a tax-free 1035 exchange allows individuals to use the cash value of an existing life insurance policy to fund a new policy with long-term care insurance benefits without incurring tax exposure. This option provides a way to fund long-term care insurance without drawing from household income.

Frequently asked questions