Most people look at life insurance as a tool for protecting their families. That is, indeed, an important component of life insurance. If you should die, your policy may help your beneficiaries pay their bills, face financial challenges, and possibly even save for the future. But you can also use a life insurance policy to build wealth. There are pros and cons to this kind of strategy, but if you’re interested, here’s how to use life insurance to build wealth.
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What is Life Insurance?
Life insurance is a contract between an insurance company and the policyholder. Generally, the contract will promise that if the policyholder dies within a certain time frame, money will be paid to the policyholder’s designated beneficiaries. People usually purchase life insurance to ensure that if they die, their family members will still have some kind of financial support.
There are several varieties of life insurance, and it’s important to know the differences if you’re going to use life insurance to build wealth:
Term life insurance. This is insurance that covers a period of time, such as 10, 20 or 30 years. If you were to die within the term that your life insurance policy covers, your loved ones would receive money (tax-free), known as a payout. If you live beyond the term, the insurance company has obviously made a good bet by insuring you because no money will be paid out. In general, people purchase term life insurance to give them the peace of mind that if they die unexpectedly, their family will have the revenue they need to pay their bills.
Permanent life insurance. This insurance is what the name suggests: it’s permanent. If you pay the premiums every month, you’ll have it until you die, whether that’s five years from now or 50. Your beneficiaries will receive a payout after you die, and while you’re alive, the policy generates a cash value.
There are two forms of permanent life insurance – whole life insurance and universal life insurance. Both cover you for your entire life and offer payouts, but there are some subtle and important differences between the two. A universal life insurance policy, for instance, offers a guaranteed minimum fixed rate. This means you’ll know that your beneficiaries will at the very least receive a certain amount of money. Your beneficiaries, however, may receive more of than the minimum payout, with the rest of the money based on how the stock market performs.
You may think permanent life insurance sounds pretty good and wonder why anyone would buy term life insurance instead. That’s because term life insurance policies are generally considerably less expensive than permanent life insurance.
How to Use Life Insurance to Build Wealth
People primarily use life insurance to build wealth for the next generation, so that a family doesn’t suddenly find themselves penniless. Often, beneficiaries will use a life insurance payout to pay off a mortgage, fund college educations and pay bills until jobs or careers can be established. Your beneficiaries may even have a little extra to put away into retirement accounts. And depending on what you purchase, a life insurance policy can sometimes be used to build your own wealth.
If you want to use life insurance to build wealth, you would buy a permanent life insurance policy. If you already have term life insurance, typically you’ll have a chance to convert it to permanent life insurance.
If you do ultimately get a permanent life insurance policy, typically people have two options for using it to generate wealth:
- Take out cash. If your permanent life insurance policy has a significant cash value, you could theoretically make a lot of withdrawals during your retirement and use the revenue to supplement your income. That will probably reduce the death benefit for your beneficiaries, but if you’ve planned to do this all along as a way to fund your retirement, this could be a good way to generate wealth.
- Take out a loan. You can also take out a tax-free loan from the money that accumulated over the years. There is usually interest on the loan but often lower than what other lenders will be charging. Paying back the loan might even be optional – but if you don’t pay it back, you will reduce the value of the payout for your beneficiaries and have less cash to take out in the future.
If you took out a loan, in an ideal scenario, you would do it to be proactive and not out of desperation. It’s not hard to imagine how a loan from your life insurance policy may generate wealth and build you a better future. For instance, if you take out a loan to make home improvements – and then you sell your home at top dollar and are able to pay back the loan, you’ll begin to see how your life insurance policy could build wealth for both you and your beneficiaries.
If there is a certificate of deposit or some other investment you are interested in, it could be worth taking out a loan from your life insurance policy. You might also take out cash or a loan to invest in a business that your son or daughter is starting, helping both your child and you build wealth.
And if money gets tight during retirement, here are two strategies to consider:
- Use the cash value to pay your life insurance premiums. If the life insurance policy has really increased in value over the years, and if money isn’t too tight but you find it difficult or inconvenient to pay the premiums, you could use the money in the policy to pay for your policy’s premiums. That would keep the policy going, so that when you did die, your beneficiaries receive a payout.
- Cancel the policy. You could receive what’s called a cash surrender value payment. This really isn’t a way to generate wealth, especially if it’s a new policy. There will be fees that you will pay for canceling, and if it’s a new policy, there probably hasn’t been much interest earned. Of course, your beneficiaries will not receive a payout when you pass on.
The Bottom Line
Figuring out how to use life insurance to build wealth is the easy part – figuring out how to do so in a way that doesn’t rob money from your beneficiaries can be a little harder. Using life insurance to create assets for your retirement can be a sound idea, at least on paper. But that may not be the case for everyone. It depends solely on your finances and expectations for your retirement and what you want to leave behind for your beneficiaries.
Life Insurance Tips
- A financial advisor can help you decide what kind of life insurance policy is best for you. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Do you know how much life insurance you’ll need? SmartAsset’s life insurance calculator can help you determine what kind of policy is most appropriate for your needs.
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