Benefit From Life Insurance While You're Living
April 14, 2014 | Your Finances
Life insurance is an important part of the foundation of your financial plan, protecting your goals and taking care of loved ones if the worst happens. But the value of life insurance goes beyond risk protection. It can be an asset – and offer other financial benefits – at various stages in life.
Living Benefits Add Value to Permanent Life Insurance
There are two types of life insurance, term and permanent, which are best known for their primary function of providing a death benefit. But if you look beyond the death benefit and understand the various options life insurance offers, you can find even more ways to strengthen your financial position.
Term life insurance provides financial protection for a specific period of time (e.g., 10, 20, or 30 years) and pays a benefit only if you die during the term. If you outlive your policy, it will expire, and your coverage will end.
Permanent life insurance, on the other hand, provides protection throughout your lifetime, as long as premiums are paid, and offers numerous additional financial benefits. Permanent life insurance policies build equity called “cash value” that accumulates over time. This accumulation of cash value, along with tax advantages available with a permanent life insurance policy, allows you to enjoy “living benefits,” including:
- Guaranteed, tax-deferred growth. Your life insurance cash value is guaranteed to grow and to never decline in value. It contributes to your financial security with stable yet consistent growth that supports your financial goals.
- “Collateral” for policy loans. The cash value you accumulate is an asset on your balance sheet with unique characteristics compared to other assets, such as your home, business, investments, and retirement funds. You may borrow money against the cash value of your policy at any time and for any reason. Among other things, policy loans can be tapped for funds to purchase a home, invest in a business or commercial property, handle a financial emergency, or supplement retirement income. You also may use the cash value as collateral to secure a loan from a bank. Cash value and death benefits are reduced if the loan is not repaid.
- Dividend payments. Though they are not guaranteed, Northwestern Mutual has paid dividends on its insurance policies every year since 1872. If a dividend is awarded, you can choose to take the amount in cash, use it to pay back a policy loan, or use it to purchase additional insurance (known as paid-up additions) that increases the death benefit and cash value of the policy. Like other cash value, reinvested dividends grow tax-deferred. Cash proceeds may be taxed if they exceed the amount you’ve paid in premium during the life of the policy.
- Flexible funds for retirement. You can use your permanent life insurance cash value to supplement your retirement income without the requirements and limitations that apply to 401(k) and IRA retirement accounts. You have several choices, including receiving your dividends in cash, surrendering paid-up additions that you purchased along the way, or taking a policy loan (all of which may have tax consequences or impact the death benefit). If you no longer need the death benefit and would like guaranteed income from your life insurance contract, you also may terminate the policy and have the cash surrender values paid out as an annuity.
- College savings. Life insurance cash value is one of the few assets not considered in federal college financial aid calculations. Families with college-age children who have permanent life insurance policies not only can use the policy’s cash value (via policy loans) to pay college tuition and housing expenses but also might benefit from greater financial aid opportunities.
- Legacy opportunities. There are many opportunities to leave a legacy through life insurance in addition to providing for your spouse, family and other heirs. If you own a business, you may consider using a policy as part of a buy-sell agreement to ensure continuity of a small business or liquidate your ownership stake upon your death. If you have a favorite charity or local cause, you can fund a legacy gift with a life insurance policy, naming the organization as beneficiary.
- Locked-in insurability. Buying life insurance early in life is the best way to lock in your insurability, whether you are a parent buying life insurance for your children or a young single person without a spouse or children. As needs change, you can expand your coverage by converting a term policy to permanent insurance before it expires or by adding to an existing permanent insurance policy using an additional purchase option.
- Long-term care. If paid-up additions have been purchased with dividends during the life of your policy, you may be able to surrender them tax-free to pay for long-term care (LTC) insurance premiums by utilizing a 1035 exchange. This will decrease the policy’s death benefit and cash value as well as future dividends but could help you to fund long-term care insurance if you so choose. There also are other options for paying LTC premiums with your cash value. A financial representative can tell you more about these options for using your life insurance policy.
- Tax benefits. Permanent life insurance offers many tax advantages, including tax-deferred growth on cash value accumulation, tax-favored access to cash value up to the basis, and generally tax-free distribution of death benefits. Life insurance is also used for estate planning to help cover estate taxes and ensure that the estate owner’s assets can be distributed as desired to heirs and family members.
Permanent life insurance is a flexible asset that can add value to your financial plan with benefits you can enjoy during your lifetime—such as accumulation of cash value, tax-advantaged growth, and accessibility through policy loans. Using these living benefits may have tax consequences, so work with a financial professional and tax advisor to understand your options and determine the best course for your individual circumstances and needs.