How to Use Life Insurance to Build Wealth

Sean McGinn is an assistant director of Product Positioning in the Insurance Solutions department at Northwestern Mutual.

Most people think about life insurance to provide for their loved ones upon passing away. But while a policy’s death benefit is the main purpose, that’s not the only way to use it. In fact, when you think about your entire financial plan, life insurance can also be a powerful tool. It can protect and even help build your wealth.

Below, you’ll see how life insurance can fit into your financial plan and the different ways you could put the cash value of a permanent life insurance policy to work.

Can life insurance build wealth like investments do?

It’s important to recognize that life insurance—whether it’s term life or whole life—is not an investment. The main reason you buy life insurance is to provide a death benefit for your beneficiary when you pass away. That way, you know they will be taken care of when you’re no longer here.

And certain types of life insurance, like permanent life insurance, have features that can help you build and grow wealth. The cash value that such policies accrue over time can provide stability and diversification to your broader financial plan. This may be one reason EY found that long-term financial plans that include permanent life insurance and deferred income annuities often perform better over time than plans focused entirely on investments.¹

To take advantage of the cash value of permanent life insurance, it’s important to understand how it works and how it can be put to use while you’re still alive.

How to use the cash value of life insurance

Cash value is a feature of permanent life insurance policies—including whole life, universal life, variable universal life and indexed universal life—that essentially allows you to build cash within your policy. Each time you pay your premiums, a portion of your payment accumulates as cash value, sort of like how homeowners build equity in their property with each mortgage payment they make. This cash value can then grow at either a guaranteed rate or at a rate connected to market performance (depending on the specific type of policy).

Below are some of the ways you can put your cash value to work growing your wealth:

Let it grow with life insurance dividends

In the context of life insurance, dividends are essentially payments that a life insurance company makes to a policyholder when the company performs better than assumed when setting policy guarantees. This performance can be driven by lower claims, lower expenses, higher investment returns or a mix of factors.

And dividends aren’t guaranteed, though some companies have long track records of paying annual dividends. Northwestern Mutual, for example, has paid dividends to policyholders every year since 1872.

If your policy allows you to receive dividends, you’ll usually have options. You can take dividends as cash, use them toward your premiums or use them to purchase additional coverage. This final option can help your cash value grow more quickly into a significant asset in your financial plan.

Fund financial goals with a loan against life insurance

Once your policy has earned enough cash value, you can borrow against it with a life insurance loan and use the proceeds of that loan to fund other financial goals. For example, you could put a down payment on a home, purchase a vehicle or fund a college plan for a child or grandchild. In this way, your cash value can help with whatever you find important in life. As a bonus, the loan is without current taxation so long as you pay it back.

But before you borrow a life insurance loan, it’s important to understand that you will need to pay it back, with interest. Your family will get a lower death benefit if you die before paying back the loan. Talk with a financial advisor or tax professional before you borrow against your policy.

“Cash out” your policy with a withdrawal or surrender

Let’s say you want to access your policy’s cash value but don’t want to pay it back like you would with a loan. You may be able to cash out some (or all) of your policy in a withdrawal or a surrender.

A withdrawal cashes out a portion of your cash value—and because it isn’t a loan, you won’t have to pay it back. The downside is that your policy’s death benefit will be lower. It’ll be reduced by the amount of cash value you withdrew, but the reduction could be greater, depending on the terms of your policy.

With a surrender, you’re essentially canceling your coverage in exchange for the surrender value of your policy minus any fees (which may depend upon the policy type and how long you’ve owned your policy). While this option gives you access to cash, it also means giving up coverage, which could leave your family at risk when you do pass away. And if your policy’s surrender value is higher than your cost basis (essentially the amount you paid in), you could owe taxes on the difference. For most people, surrendering a policy should typically be a last resort.

Use it as income during retirement

During retirement, the cash value of your life insurance policy can become a source of income that complements other income sources like your retirement accounts, annuities or Social Security payments. Besides simply providing you with more cash to spend, this also gives you the flexibility to think strategically about where you pull money from each year.

During a down market, for example, the value of your retirement savings will probably take a hit. Selling assets to cover your living expenses means locking in these losses, which can have significant negative effects on the remainder of your retirement. You might instead choose to access the cash value of your life insurance policy via a loan or withdrawal to cover your living expenses—giving the rest of your retirement assets more time to recover.

And the flexibility offered by cash value can increase your options for tax efficiency during retirement, which can be helpful if you rely primarily on savings held in a tax-deferred account like a traditional 401(k) or IRA. Cash value can help you stay in a lower tax bracket during years when your expenses are unusually high—again, allowing you to stretch your savings further. That’s because tax-free loans or withdrawals from the cash value can supplement your retirement income without increasing your taxable income.

Other ways life insurance can help protect wealth

Cash value isn’t the only way you can use your life insurance policy to build and protect your wealth. Some other options include the following.

Minimize estate taxes

If you create an Irrevocable Life Insurance Trust (ILIT) and fund it with your life insurance policy, you’re essentially removing the policy from your estate. This can help you avoid estate taxes that might otherwise be due on the death benefit. Just remember that the “irrevocable” part of its name means that it’s not designed to change.

Leave a charitable legacy

Donating your policy can help you leave money to a nonprofit once you’re gone. There are two main ways to do this.

If you want to maintain control over your policy while you’re alive—for example, to be able to access your policy’s cash value—you could name a charity as a beneficiary. Then, upon your death, the organization would receive the policy’s death benefit free of tax. You could even set it up so that some money goes to a family member with the rest to the charity.

Or you could transfer ownership of the policy to the charity. While this means you give up the rights associated with your policy, such as the ability to access its cash value, it can also get you a significant tax deduction. Just make sure the charity is equipped to handle this financial tool.

A valuable part of your financial toolkit

Life insurance can be a flexible, powerful tool for protecting your family and your wealth—and helping build it. But it’s important that you understand how cash value works and the pros and cons of tapping into it. Your Northwestern Mutual financial advisor can help you understand if and when it makes sense to access your policy’s cash value and answer other questions about the role of life insurance in your overall financial plan.

By looking at your whole financial picture, your advisor can point out opportunities and blind spots that might otherwise go overlooked. Together, you can update your plan as the years go by.

Loans taken against a life insurance policy can have adverse effects if not managed properly. Policy loans and automatic premium loans, including any accrued interest, must be repaid in cash or from policy values upon surrender, lapse or the death of the insured. Repayment of loans from policy values upon surrender or lapse can trigger a potentially significant tax liability and there may be little or no cash value remaining in the policy to pay the tax. The policy will lapse if loans become equal to the cash value while the policy is in force and additional cash payments are not made. Utilizing the accumulated value through policy loans, surrenders, or cash withdrawals will reduce the death benefit; and may necessitate greater outlay than anticipated and/or result in an unexpected taxable event. Assumes a non-Modified Endowment Contract (MEC).

Dividends are not guaranteed. This publication is not intended as legal or tax advice. Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation.