Life insurance can benefit you while you’re alive
Life insurance is typically viewed as just a payout when you die. But this coverage can provide much more if you’re willing to look past a few common misconceptions.
A recent survey from Corebridge Financial found 47% of Americans with life insurance policies feel confident their spouse or dependents would be able to manage financially without them, compared with 28% of those without life insurance. Furthermore, 4 in 10 cited cost as the top reason for not purchasing a policy and 21% said they have more important financial considerations.
What most people don’t know is that these policies can benefit you while you’re still living. In light of Life Insurance Awareness Month this September, let’s debunk some of these misconceptions and explore how the right policy can benefit you, your loved ones and future generations to come.
I often find that when people hear the term “life insurance,” they simply picture the insurance company sending check to their surviving loved ones. Although that’s important, it’s only part of the story. Properly designed life insurance can be one of the most versatile tools in personal financial management, helping to supplement income in retirement, provide tax advantages, cover unexpected health events and even provide liquidity all while you are still living. The key is to work with an agent who knows how to properly design a policy to optimize cash values.
Tax-deferred growth
The cash value in a permanent life insurance policy – such as whole life or indexed universal life – grows without being taxed annually, unlike a 401(k) or an individual retirement account. In fact, you don’t owe taxes on the growth unless you withdraw more than you contribute.
No required minimum distributions
For many retirement accounts, such as 401(k)s and IRAs, the government forces you to take required minimum distributions, usually starting once you turn 73. However, life insurance policies with a cash value gives you the ability to let those funds grow for as long as you want. You will not be forced to start making withdrawals and pay taxes on those withdrawals once you reach a certain age.
Loan optionality
Instead of withdrawing funds from your policy, which could trigger taxes, you can take a loan against your cash value. These loans don’t count as taxable income, allowing you to access the money without owing the IRS. If the policy is designed properly, your cash value will continue to grow even when you borrow against it.
Another perk is uninterrupted growth. When you borrow against the cash value, if the policy is designed properly, the cash value will continue to grow as if you never touched it. So if your cash value earns a 4%-6% net internal rate of return, it still compounds even if you’re using that money elsewhere.
Taking a loan against the cash value of your policy can usually leave you with a better interest rate. And since your money still grows even when borrowed against, the effective cost of the loan is typically lower than any outside debt, even a 0% credit card.
Creditor protection
In many states, the cash value within a life insurance policy is safeguarded from creditors. In other words, if you get sued or declare bankruptcy, that money may be protected.
Understanding the benefits of a cash value policy is only a piece of the puzzle. In fact, there are several different branches of policies that have cash value components and they aren’t made equally.
Whole life insurance
When it comes to the components of a whole life policy, there’s typically a base premium, term rider, paid-up additions, dividends and optional riders.
The base premium is the core payment for the permanent life insurance policy. It provides a guaranteed death benefit and cash value growth.
The term rider provides additional short-term coverage. It lowers the overall cost and commissions compared to buying all coverage as permanent. It also helps keep base policy premiums lower so that more money can go to cash value PUAs.
PUAs are extra premiums allocated immediately to create cash value. The cash value grows with guaranteed interest plus dividends. PUAs are available for loans or withdrawals with minimal surrender penalties. It should be noted that it is possible to reduce cost in a policy by changing the amount that goes toward the base premium versus PUA. For example, a $10,000 premium could only have $1,000 going toward cost of insurance and the other $9,000 going toward the cash value component.
In modern policies, dividends typically account for 5%-7%, including minimum guaranteed interest. Dividends act as a low-risk bond replacement for long-term growth.
There are various types of optional riders. A long-term care rider allows you to access part of the death benefit for long-term care costs. A disability/waiver of premium allows the policy to continue if you become disabled. An automatic premium loan provision uses the policy’s cashflow to automatically cover missed premiums so the policy doesn’t lapse. If an outstanding policy gets too high, an overloan protection rider can prevent the policy from collapsing by converting it to a reduced paid-up policy.
Whole life insurance tends to bring about the most confusion when it comes to policy structure due to nonparticipating and participating policies. They are always principal-protected. So, if you’ve ever heard about a whole life policy building with no cash value, it means the insurance company that placed the policy is a stock-owned company and not a mutually owned company. Mutually owned companies are considered participating policies because policyholders are participating in the profits of a company, whereas stock-owned companies are nonparticipating.
Universal life insurance
Universal life policies is where the cash component is unbundled from the insurance cost. With these policies, there is a funding flexibility that provides a window for how much premium can be put into the policy. Premiums can also vary. In some cases, you can skip paying the premium as long as there is enough cash value to cover the charges. These policies are also flexible allowing you to adjust the death benefit over time. However, if the policy isn’t funded properly, it could collapse. These policies are usually best used as guaranteed universal life or survivorship universal life policies.
Indexed universal life insurance
Indexed universal life policies are arguably the most popularized of all life insurance policies.
They’re typically purchased to optimize potential gain to average between 5%-7% growth long-term while mitigating the risk in the market. While the principal is protected from market losses, it isn’t protected from the cost of insurance when the market losses happen. If cash value is the goal, the policy should follow these rules:
- Should be structured as maximum cash, minimum death.
- The death benefit needs to be an increasing death benefit to start and usually switches to a level death benefit whenever you plan to cease adding premium.
- High early cash value riders can be added to the contract to ensure the ability to access money from the contract earlier.
Variable universal life insurance
Variable universal life insurance is an investment product. The easiest way to think about this type of policy is that it behaves similarly to a Roth 401(k) with investment choices and risk, yet it’s placed within a life insurance wrapper for tax advantages. Inside the policy are the investments you control in a subaccount that can move up or down. The insurance company doesn’t guarantee growth because you’re taking investment risk. The fee structure is also more aggressive because the idea is that with uncapped growth potential, growth should outpace the fees.
In essence, life insurance is more than just a death benefit mailed to your loved ones after you die. These products can be structured to provide you with financial security and support throughout many phases of your life. You can purchase policies that help protect you and your family before your health becomes a concern or a factor driving you away from seeking life insurance. The key is to understand the products and structures out there and to seek the right guidance.
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