Life insurance as an investment may be an option if you want to provide security for your family after you die, while also supporting you financially in the future with options such as loans or withdrawals.
- Life insurance isn’t just there to benefit your loved ones after you die. With certain insurers, you may be able to take out policies that enable you to grow cash value over time.
- Withdrawing money from your insurance policy may require you to pay income tax, depending on the amount you’ve gained.
- Only universal or whole life policies allow you to grow the cash value of your policy, which lets you take money out. Term policies, on the other hand, don’t grow over time.
Life insurance is a way to help secure your loved one’s future in the event of your death. But another option is to use life insurance as an investment and a financial asset that you can benefit from during your life.
Not all life insurance investments offer this possibility, so it’s important to understand the different types of policies and the potential implications of using those funds before death.
The Purpose of Life Insurance
The traditional reason many people take out life insurance is to be used as a benefit after the policyholder dies, so that their family is left with some financial protection.
However, it’s not the only reason people invest in life insurance. Increasingly, people are using permanent or whole life insurance policies as an additional investment in life, not just death.
The Cash Value Component in Permanent Policies
It's important to understand that not all insurance policies are the same. Only permanent or whole life policies enable you to grow a cash value over time, based on how your funds are invested or the interest they gain.
Different Life Insurance Policy Types
There are several types of insurance that allow you to accumulate a cash value, differing slightly in their flexibility and growth of value over time.
Whole life insurance
Whole life insurance typically involves fixed premiums and a guaranteed death benefit amount. Cash value grows over time, usually at a fixed rate set by the insurance provider.
Universal life insurance
Universal life insurance is somewhat more flexible, allowing you to increase or decrease your premiums and death benefit if your needs change over time.
Interest is usually based on the insurance company’s declared interest rate, which can fluctuate. While it is more flexible, this fluctuation makes it riskier than whole life insurance.
Variable universal life insurance
This allows you to adjust your premiums and death benefits, with the addition of choosing how your money is invested. Overall, you get more control over your cash value and policy. These policies earn interest based on the performance of your chosen subaccounts and the insurer’s fixed rate.
Indexed universal life insurance
This type of policy is similar to universal life insurance due to its flexibility. However, the main difference is in how the cash value earns interest. Your cash value may grow or decrease in line with the performance of stock indexes, such as the S&P 500. Some policies offer interest floors to protect against heavy market losses, and some also have maximum interest rate caps.
How To Use Cash Value as an Investment
Contributing to your life insurance policy over several years in one of these policy types allows you to benefit from the amount you have saved. There are a few different ways to do this.
Loans
Some insurance plans allow people to take out a loan based on their contributions. Providers may have different policies on interest rates, either fixed or variable, so it’s always worth reading the fine print.
One thing to note about taking a loan out of your life insurance amount is that if you don’t repay it by the time of your death, any outstanding balance may be subtracted from the amount your beneficiaries receive.
Withdrawals
Another option besides taking out a loan that you will have to pay back is to make a withdrawal from your policy. However, if your withdrawal is large enough to affect your investment gains, you will need to pay taxes on the amount.
Just like with a loan, any money you withdraw will be less money paid out to your beneficiaries later.
Using as collateral
One way to avoid dipping into the funds from your policy is to use it as collateral for another loan. With collateral, it may be easier to get approved or secure a better rate. However, if you don’t pay back your loan before the time of your death, anything you still owe will come from your remaining estate, which could affect how much your beneficiaries receive.
Surrendering the policy
To surrender your life insurance policy essentially means canceling your coverage so that you can receive the value of what you’ve paid in (minus any charges applicable from your insurance company).
Tax Considerations
If you are considering using life insurance as an investment, it's important to consider the tax.
In the case of withdrawals, you may be able to withdraw up to the amount you’ve paid into the policy without paying tax. However, if you have made more money than you've paid in, you may have to pay tax on the gains.
One way some people avoid paying tax is to take out the amount as a loan. Loans are not taxed as income, but will involve paying interest. If your loan exceeds the total cash value, your policy may lapse. That’s why you might consider paying at least the annual interest so that the loan doesn’t grow over time.
Weighing Pros, Cons, and Common Misconceptions
Is using life insurance as a retirement component the right choice for you? Carefully assess the pros and cons before considering it.
Key advantages
Policyholders of whole life insurance policies may benefit from using life insurance to build wealth.
Low-interest loans
One advantage of cash value or universal loans is that you may be able to secure low-interest-rate loans. If you use your policy amount as collateral, lenders may be more willing to offer better rates or higher amounts.
Benefit from the money earlier
Life insurance as an investment allows you to benefit personally and earlier in life, while also retaining some protection for your loved ones later on.
Limitations and trade-offs
Like many wealth-building strategies, it's worth looking at the trade-offs before you make a decision.
Higher premiums
In some cases, you may find that universal life insurance policies have higher premiums than traditional term policies.
Impact on your beneficiaries
While it may be tempting to try to benefit earlier from your insurance, this also has an effect on your loved ones after you pass. Any unpaid loans or withdrawals will reduce the amount they receive after your death.
Common Misconceptions of Using Life Insurance as an Investment
You may have heard different things about life insurance investments, but what is the reality?
Myth: You can use any type of life insurance as an investment
Reality: Only life insurance that’s labeled as ‘whole’ or ‘universal’ may be used in this way. For regular term-based insurance policies, you won’t be able to cash out of your policy and receive the money you have paid in.
Myth: Your remaining cash value is passed on to your heirs
Reality: While your policy may have a cash value, this is typically not added to the life insurance death benefit. This means it’s a benefit you will only be able to make use of while still alive.
Myth: Loans are written off after you die
Reality: Any loan you take from your cash value will have an effect on the amount your family receives after you die. If you withdraw cash or don’t pay back your loan, the death benefit is reduced by the same amount or more.
Final Thoughts
Life insurance as an investment may have its benefits, but there are important things to consider before taking out any money from your policy. If your goal primarily is to provide for your family after death, then it may be better to find other ways of growing your wealth without impacting them.
If you want to secure your wealth in the future, life insurance is an option, but not the only one. Speak with a qualified financial advisor before making any decisions about wealth-building strategies.
