You may be familiar with life insurance death benefits: the sum of money that gets paid out to your loved ones when you die. But did you know that life insurance can be an important financial tool with benefits that you can take advantage of during your lifetime and beyond? The fact is, some life insurance policies come with a cash value component that allows you to use life insurance to build wealth.
How to Leverage Life Insurance
Life insurance can be a crucial part of the overall financial plan of any individual or family. Life insurance can help you and your family meet certain financial goals throughout your lifetime and create wealth for the long-term.
Death Benefit: Financial Security for Your Family
The main function of life insurance is to provide protection in the form of financial security for your family. Every life insurance policy comes with a death benefit, which is a lump sum of money that gets paid out to the loved ones you name as beneficiaries when you die. These life insurance proceeds are usually treated as tax free income, so your beneficiaries would not have to pay taxes on it.
This aspect of life insurance protects your family in the event of your early or unexpected death by aiding with financial burdens and stressors like final expenses, outstanding debts, and the loss of expected income upon which your family depends.
Term vs Permanent Life Insurance
If you want your life insurance policy to do even more for you in terms of building wealth, the most important place to start is knowing the difference between term and permanent life insurance.
Term life insurance is purchased and remains active only for a set period of time, as long as you pay the policy premiums. The only benefit that comes with a term life insurance policy is the death benefit, which only remains in effect as long as the term of the term life insurance policy is active. In some cases, the term policy can be renewed, but the cost would increase according to the age of the insured person. This is one of the potential drawbacks of opting for term life insurance, even if the lower premiums seem appealing at first.
Permanent policies have several advantages compared to term life insurance, with two standing out as most notable.
First, as the name implies, permanent life insurance does not expire after a specific period of time. As long as you pay the policy premiums, permanent life insurance and its guaranteed death benefit will remain active for the entire lifetime of the insured person, and the cost will not increase over time.
The second advantage of permanent life insurance is the cash value component, which is the part that can help you build wealth. Part of the premium payments you make for a permanent life insurance policy each month are apportioned to the policy’s cash value account, which grows with interest on a tax-deferred basis.
The interest rates vary by company, and can come with some market risk, but they can be quite favorable compared to traditional investment options: for instance, the current interest rate for American Fidelity Life Insurance Company is 5%, with a guaranteed minimum of 3%, meaning that your policy can build cash value by quite a lot throughout the insured’s lifetime.
The two main types of permanent life insurance companies are called whole life insurance and universal life insurance. They are very similar, but have important differences that vary by company. Talk to an agent if you wish to learn more about universal life insurance and whole life insurance, and how they can help you build wealth.
Accumulate Cash Value: Life Insurance Living Benefits
The cash value component of a permanent life insurance policy is also referred to as a “living benefit.” In contrast to the life insurance death benefit of a policy, which is only available at the time of the insured’s death, the cash value of the policy is referred to as a living benefit because it can be used in certain ways while the insured is still alive. Both whole life insurance and universal life insurance have this added opportunity to accumulate cash value.
Life Insurance Policy Cash Value
A life insurance policy’s cash value can be used in a variety of ways. For instance, you can take partial withdrawals from the cash value, or even borrow against the value to take out loans which can be repaid at your convenience, again at a favorable interest rate. This is money that can be instrumental toward meeting major life financial goals for your family, such as purchasing a car, putting a down payment on a house, or paying toward college for your children.
These are major milestones that can improve your family’s quality of life, but also contribute toward building wealth: owning a home represents a real estate investment that can be an effective way to build wealth, and a college education for your children will greatly improve their chances to earn a good income later in life.
Cash Value Accumulation
You can also simply let the policy’s cash value grow. As stated earlier, cash value accumulation can compound by quite a bit over time. If you wait long enough before touching the cash value, you might even be able to pay for the premiums of your life insurance policy off of the interest being generated by the significant cash value alone. This means your policy would remain in force for the rest of your life without you having to pay premiums each month.
Partial Surrenders
A partial surrender is a withdrawal of a certain amount of money from the cash value. It will reduce the cash value of the policy. Depending on the specific type of policy and the company’s rules governing that policy, a partial surrender may reduce the policy’s death benefit as well. However, in contrast to a full surrender, a partial surrender will not terminate the policy.
Borrowing Against Cash Value
There are also specific rules for borrowing against the cash value of a life insurance policy, such as when borrowing can occur, what the interest rate of the loan is, how quickly the loan must be paid back, and what happens if the insured dies before the loan is repaid. Talk to a life insurance agent to get a better sense of these specific rules, which would also be spelled out in the details of a life insurance policy once issued to you.
Supplement Retirement Income
If you leave the cash value of your life insurance policy relatively untouched, it can grow enough to provide you with a substantial amount of retirement income to live off of in your later years, or to help you continue supporting your dependents after you retire.
Estate Plan and Generational Wealth
You can use life insurance to build generational wealth as well. When you die, the death benefit paid out to your loved ones is treated as nontaxable income, making it a good way to pass on wealth to the next generation without incurring hefty income tax. Furthermore, any remaining cash value from the policy would also be paid out to your beneficiaries, although the portion of this value generated from interest would be subject to income tax. The additional life insurance proceeds from this cash value can be a good tool for estate planning for this reason.
Getting Good Advice
The wealth-building potential of a life insurance policy makes it a valuable tool to add to your overall financial plan. For that reason, you may wish to seek advice about which life insurance options make the most sense for you, not just from a life insurance company, but from your other advisors as well.
Financial Advisor
A financial advisor will have a good sense of you and your family’s overall financial circumstances and goals, giving them a bird’s eye view of how life insurance can fit into your financial plan. They may be able to advise you, for instance, on how to best leverage your policy’s cash value in the context of your financial obligations, future expenses, goals for transferring wealth to family members and future generations, and so forth.
Tax Advisor
A tax professional can further help you understand the income tax implications and tax advantages of your life insurance policy, both in terms of how the nontaxable death benefit can help with estate planning, and how to approach the timing of partial surrenders or other uses of the policy’s cash value. Their tax advice can help you better understand the tax consequences of taking advantage of your policy’s living benefits.
Start Building Wealth with Permanent Life Insurance from American Fidelity
While a financial advisor and tax advisor can both be important pieces of the puzzle, ultimately a life insurance agent will know the most about the benefits and other details of your life insurance policy: the rate at which cash value is expected to accumulate, the specific rules and restrictions surrounding the cash value component, and so forth. Talk to an agent today to learn more about how our life insurance policies can help build wealth for you and your family.
