When most people think of life insurance, they usually associate it with providing financial support to loved ones after their passing. However, certain life insurance policies can function as a financial asset during your lifetime, much like a mutual fund. These policies allow you to build and access cash value over time, offering options to withdraw funds or borrow against them, and if structured correctly, you can even do so without triggering tax liabilities.
Not all life insurance policies are alike. If you’re seeking a policy that can serve as both a safety net and a financial asset, it’s crucial to look for policies with a cash value component. Typically, only permanent life insurance policies offer this feature, as term life insurance—which is generally cheaper and valid for a specific number of years—does not include a savings mechanism you can tap into.
Let’s explore some of the types of life insurance policies that can serve as a financial asset, how they work, and what to be mindful of when accessing them.
Types of Life Insurance That Build Cash Value
Permanent life insurance policies are designed not only to provide a death benefit but also to allow the policyholder to invest in conservative financial instruments, like mutual funds. These policies enable you to diversify your investments according to your goals and risk tolerance, providing a buffer against market volatility. The two primary types of permanent life insurance that offer this investment feature are whole life insurance and universal life insurance.
Whole Life Insurance
Whole life insurance is the most common type of permanent life insurance. It offers a guaranteed death benefit alongside the opportunity to accumulate cash value. Each month, a portion of your premium is placed into a cash value account, which grows at a guaranteed rate specified in the policy. Think of it as a combination of life insurance and a savings account. Another advantage is that premiums typically remain fixed for the life of the policy. However, always read the fine print to understand the exact terms and rate of growth.
Universal Life Insurance
Like whole life, universal life insurance allows you to build cash value by accruing interest over time. You can borrow against this value just as with whole life insurance. However, there are a few key differences. Universal life insurance doesn’t guarantee fixed premiums, meaning your payments can fluctuate over time, and the interest rate you earn may vary as well. Under the universal life umbrella, there’s an option called variable universal life insurance, which allows you to invest your policy’s earnings into a variety of accounts, including mutual funds, providing the potential for higher returns.
How to Leverage Life Insurance as a Financial Asset
As you pay into your life insurance policy over time, you build cash value that can be used in different ways. These options offer flexibility and tax advantages, but there are also risks to consider.
- Taking a Loan Against Your Policy
One option is to borrow against the cash value of your policy. Interest rates for these loans may be fixed or variable, depending on the insurer. While this provides quick access to funds, any outstanding loan balance that isn’t repaid by the time of your death will reduce the amount your beneficiaries receive.
- Using Your Policy as Collateral
In some cases, your life insurance policy can serve as collateral for loans, improving your chances of approval or helping you secure a better interest rate. However, if the loan isn’t repaid before your death, the amount still owed will be deducted from your death benefit.
- Withdrawing Funds
Instead of borrowing, you can make direct withdrawals from your policy’s cash value. While you don’t have to repay these amounts, keep in mind that withdrawing from your investment gains can trigger tax liabilities. Additionally, your death benefit will be reduced by the amount you withdraw, lowering the payout to your beneficiaries.
- Accelerated Benefits
Some life insurance policies offer an accelerated benefit option, allowing you to access a portion of your death benefit early if you face a critical illness, such as cancer or heart failure. You can often withdraw 25% to 100% of your policy’s value, depending on the policy terms, providing financial relief during a health crisis.
- Surrendering the Policy
If you no longer want to keep your life insurance policy, you have the option to surrender it, effectively canceling your coverage. In this case, you’ll receive the cash value you’ve built up, minus any surrender fees. However, be cautious—these fees can sometimes be steep, similar to early withdrawal penalties from retirement accounts. If your financial situation changes and you no longer need the coverage, surrendering the policy might be a worthwhile option, but it’s essential to understand the costs involved.
Using life insurance as a financial asset offers flexibility and can help you meet both immediate and long-term financial goals. However, it’s crucial to understand the structure of your policy, the associated costs, and potential impacts on your beneficiaries. Always review the fine print and consult with a financial advisor to ensure that your life insurance policy aligns with your overall financial strategy.
