Can you use life insurance to build wealth?

Life insurance is often viewed as a crucial form of protection, helping grieving family members cushion the financial impact of losing a loved one. With the right policy, this type of cover can assist families in paying off loans and debts, as well as provide them with the monetary means to meet daily living expenses.

However, this kind of financial benefit is just one of the several elements of life insurance. Like other types of policies, it is a complex investment with its share of benefits and drawbacks – and depending on how it is managed, life insurance can also be used as an effective strategy to build wealth.

Read more: Life insurance – the uncertain private equity future

How does life insurance work?

Life insurance plans are available in several variations but generally fall into two categories – term and permanent policies. Each comes with its share of pros and cons and the key to determining whether one is a good investment is understanding how it works.

Term life insurance

As the name suggests, this type of policy covers the policyholder for a set term. It pays out a stated amount, called death benefit, if the insured dies within a specified period, meaning they can only access the payment in the years that the plan is active. Once the term expires, the policyholder has three options: renew the policy for another term, convert it to a permanent coverage, or terminate the plan.

Permanent life insurance

Unlike term life insurance, a permanent policy does not expire. It comes in two primary types – whole life and universal life plans, which combine the death benefit with a savings component.

Whole life insurance policies offer coverage for the entire lifetime of the insured and the savings can grow at a guaranteed rate. Universal life insurance, meanwhile, uses different premium structures, with the earnings based on how the market performs.

Read more: 'Great resignation' piles pressure on life insurers

What are the benefits of permanent life insurance?

One of the main advantages of a permanent life insurance policy is that it can be used as an investment tool to accumulate wealth. Here are some other benefits of this type of coverage, according to the financial website Investopedia.

1. Tax-deferred growth

Permanent life insurance allows the policyholder to invest on a tax-deferred basis, meaning they are exempt from paying taxes on any interest, dividends, or capital gains on the plan’s cash value, unless they withdraw the proceeds.

“This is similar to the tax benefits you get with certain retirement accounts, including IRAs, 401(k)s, and 403(b)s,” Investopedia explained. “If you're maxing out your contributions to these accounts year after year, investing in permanent life insurance for tax reasons may make sense.”

2. Lifetime coverage

Permanent policies cover the insured for life, unlike term life insurance, which ends coverage after a set number of years.

“If you anticipate people being financially dependent on you beyond the length of a typical term policy – for example, a disabled child – this benefit may be attractive to you,” the financial website noted.

3. Access to cash value

Policyholders can borrow against the cash value of a permanent life insurance policy if the need arises without incurring penalties, unlike in tax-advantaged retirement plans such as 401(k).

4. Accelerated benefits

Insureds may be able to receive between 25% and 100% of their policy’s death benefit even if they are still alive if they develop a critical illness – including invasive cancer, heart attack, renal failure, or stroke – and use the money to pay for medical bills.

Investopedia pointed out, however, that these benefits are not unique to permanent life insurance, adding that people can often access these in other ways “without paying the high management expenses and agent commissions that come with permanent life insurance.”

What are the drawbacks of a permanent life insurance policy?

Cost is among the biggest drawbacks of permanent life insurance plans. It requires policyholders to pay higher premiums compared to term life coverage. Permanent policies can also have tax implications if the beneficiaries opt to surrender coverage or if the insured dies with outstanding loans. Additionally, borrowing from the cash value or accessing accelerated benefits can reduce the payout amount.

Read more: Life insurance satisfaction flat despite pandemic – J.D. Power

How can policyholders build wealth through life insurance?

Permanent life insurance plans enable policyholders to accumulate cash value in addition to the death benefit. They can use these funds to pay their premiums, take out a loan at a lower rate than banks offer, and supplement their retirement income. Additionally, according to Investopedia, insureds can utilize the cash value built-up in their policies to “create an investment portfolio that maintains and accumulates wealth.”

But how exactly do permanent life plans build up cash value? According to the financial website, cash value accumulates as the premiums policyholders pay are split up into three portions. One part of the payment goes toward the death benefit, another covers the insurer’s operating costs and profits, and the rest is allotted to the plan’s cash value.

“The life insurance company generally invests this money in a conservative-yield investment,” Investopedia noted. “As you continue to pay premiums on the policy and earn more interest, the cash value grows over the years.”

Accumulation, however, slows down over time.

“In the early years of your policy, a larger portion of your premium is invested and allocated to the cash value account,” the financial website explained. “Generally, this cash value can grow quickly in the early years of the policy. Then in later years, the cash value accumulation slows as you grow older and more of the premium is applied to the cost of insurance.”

Investopedia added that cash value accumulation varies depending on the type of policy. Whole life plans, for instance, offer guaranteed cash value accounts that “grow according to a formula the insurance company determines,” while universal life policies build up cash value based on current interest rates.

Source: Investopedia

The financial website also advised permanent life insurance policyholders to utilize the accumulated cash value in their plans rather than simply ignoring them.

“Don’t let cash value that has built up in your policy go to waste; cash value in your policy at your death goes back to the insurance company, not your heirs,” the firm noted.

Learn more @Insurance Business America

Previous
Previous

Why Millennials Need to Start Thinking About Life Insurance Now

Next
Next

What are living benefits of life insurance?