How to use life insurance to build wealth

People with permanent life insurance policies have additional ways to build wealth


Life insurance is essential protection against financial losses that may come along with losing a loved one. Grieving family members immediately receive a monetary cushion through the policy’s death benefit. Depending on the amount, the coverage may be enough to cover daily expenses and loan payments. Besides, this kind of financial benefit may be a part of an effective strategy to build wealth.

Types of life insurance

Not every life insurance presents the same opportunities to enrich its owners. The policies divide into term and permanent ones. 

  • Term life insurance – covers the policyholder for a specified term. Once it expires, you have three options: renew the term policy, convert it to permanent coverage, or terminate the plan.
  • Permanent life insurance – offers coverage for the entire lifetime of the insured. Besides, it has a savings component. A permanent policy can be of two types: whole life and universal life plans. 
  • Whole life insurance – accumulates cash value that accrues interest at a fixed rate and on a tax-deferred basis.
  • Universal life insurance – has an investment savings element and low premiums similar to term life insurance. Policyholders can adjust their premiums and death benefits. Besides, the cash value earns interest based on the current market or minimum interest rate, whichever is greater.

Cash value

Cash value is the portion of your insurance policy that earns interest. It may be available for the insured person to withdraw or borrow against in an emergency. For most whole life insurance policies, some percentage of premiums goes into an investment account. Universal insurances have the same savings principle. However, they use different calculation methods to accrue interest. 

You can typically borrow against your cash value account with a low-interest life insurance loan. As an alternative, premium payers may withdraw the cash (either as a lump sum or in regular payments) or surrender their policies for reimbursement. When the policy matures, the cash value increases. Thus, the longer you pay premiums, the more spare money you may put to good use. 

What do you get when you surrender life insurance?

People who cancel their whole life insurance receive the cash value their policy has built over time. The cash surrender value of an annuity is a sum of the total contributions and accumulated earnings, minus prior withdrawals and outstanding loans. Yet you need to be careful. Possible surrender charges might wipe out most of the cash value. 

The surrender fee covers the costs of keeping the insurance policy on the insurance provider’s books. It is usually 10%–20% but can be as high as 35%–40%. Moreover, you’ll have to pay taxes on any gains earned on the cash value portion of the policy in case you surrender. 

On the other hand, you’ll give up the death benefit. Thus, surrendering a policy for cash is not always the best option. 


Withdrawing cash value

Those who wish for the death benefit to ease the lives of their heirs may still utilise the accumulated cash value within their lifetime. Withdrawals are a common practice. If you do it properly, you can re-invest the money life insurance brings. 

The procedure is simple. You notify the insurer ​​how much you want to withdraw, and it will wire the cash to you or deposit it into your bank account. Moreover, that amount may come tax-free. Legally, most withdrawals are a return of your “basis” deposit – the amount transferred from your premium to the savings account. However, if you decide to cash out the earnings portion of your aggregated cash value, you are not exempt from paying taxes. 

Another point to consider is what happens with your wealth after you pass away. Withdrawing cash from a life insurance policy ultimately reduces the death benefit. That means your beneficiaries will get less when you die. Thus, cashing out makes sense for wealth-building only if you have more lucrative ways to invest the money. 

Cash value loans

The policy’s cash value may act as collateral for the policy loan. The terms of the loan depend on your specific contract. Many insurance policies allow borrowing against the built-up funds only after a certain period, typically a decade. In addition, insurers have varying guidelines on the minimal cash value eligible for a loan and the percentage of cash value you can borrow.

The repayment options are flexible. For example, you can make periodic payments with annual interest payments, pay only yearly interest or deduct the interest owed from the cash value still in your policy. Typical interest rates are 5%-8%. 

If you don’t pay back the policy loan during your lifetime, the amount is deducted from the death benefit when you pass away. Therefore, your beneficiaries will receive less, repaying the loan from the intended safety net. Furthermore, if the interest piles up and you owe more than you have in your policy, it will lapse. An insurance lapse means no more liability insurance coverage in case of your death. 

Is it profitable to sell your life insurance?

Another way to get cash when you need it is to sell your life insurance policy and the rights to your death benefit. Selling a life insurance policy is called a life settlement. Direct sales from one customer to another customer are rare. As a rule, you sell the insurance to a third party, usually a broker or settlement company, for cash. They find an interested buyer who’ll pay your premiums and receive the death benefit when you die.

The profit from this sale will be 2-7 times more than the policy’s cash surrender value but less than its face value – death benefit. Moreover, brokers and settlement companies do charge their fees for the service. Using a life settlement, the insured person can supplement their retirement income with a largely tax-free payout. 

Furthermore, if premiums get too high for you to pay, the life settlement allows you to avoid extra debts. They can be a valuable source of liquidity for people who would otherwise surrender their policies or allow them to lapse. 

Elderliness and short life expectancy are the main conditions needed to sell your policy. The ideal candidate for a life settlement is someone at least 70 years old. The policy should have a face value of at least $100,000, although some experts recommend a minimum of $200,000. Policyholders with significant health impairments qualify at any age. The life expectancy of the policyholder is usually less than 20 years. Some buyers require the insured to have a medical exam, while others simply review the person’s medical records.

Nevertheless, those opting for life settlement should consider a few factors. Firstly, the payouts may be taxable. Usually, the settlement amount minus the total premiums paid incurs taxes as a capital gain or income. Besides, receiving a lump sum of cash can disqualify the policy seller for Medicaid. 


Exchange life insurance for annuity

Annuities are insurance products providing guaranteed income in retirement. If your policy allows it, you can convert your life insurance into an income annuity without paying taxes on your gains. Your advisor will lay out your annuity options. They may be fixed or variable. 

  • Variable annuities are equal to securities and regulated by the SEC.  Their payments vary according to the performance of an underlying investment portfolio.
  • A fixed annuity guarantees a fixed rate of return on your contributions for a specific period. 

Based on your financial plan, an annuity may be a solid addition to your investment portfolio. Although these financial instruments do not provide returns that rival securities and other growth investments, some annuities offer higher growth potential. 

Bottom line

There are significant drawbacks to using life insurance to meet immediate cash needs. Most importantly, you may compromise your long-term goals or your family’s financial future. At the same time, leaving the cash value amount sitting idly in the dedicated account is not always the best way to gain wealth. Therefore, many people prefer to use one of the available methods to maximise their income with the help of life insurance policies. 

If you do it wisely, insurance may become a great source of non-taxable income. At the same time, you should carefully weigh all possible options. Calculate risks and capital gains before exchanging your policy for money, as most ways to build wealth presuppose losing the death benefit. 


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Nina Bobro

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Nina is passionate about financial technologies and environmental issues, reporting on the industry news and the most exciting projects that build their offerings around the intersection of fintech and sustainability.