How to Use Life Insurance As a Financial Tool
Life insurance is a financial product designed to provide your family with money after your death. However, some life insurance policies can be used during your lifetime. These policies provide a savings component that effectively combines insurance and investing. Learn how a policy can work as a financial tool before you buy one. Otherwise, you may end up wasting money and not accomplishing your financial goals.
Other People Are Reading
-
Types
-
There are two types of life insurance. The first, term life insurance, provides a temporary death benefit for a set number of years or a death benefit that can be renewed every year with a guaranteed increase in cost. The former type of term insurance is called "level term life," while the latter is called "annual renewable term life." The second type, permanent life insurance, is designed to stay in force for the individual's entire life.
Features
-
Term life insurance may provide a level death benefit in exchange for premium payments, but it may also provide death benefits with additional features. These features include a return of all of the premiums paid to the policy or the ability to spend the death benefit prior to your death if you are terminally ill. Permanent life insurance often provides a cash value reserve. This reserve is a savings that is invested by the insurance company (into bonds) or by you (into mutual funds). Features specific to permanent life insurance policies may include the ability to use the cash values to pay for future premiums as well as withdrawals of the cash value from the policy and policy loans.
-
Strategies
-
When purchasing term life insurance, the policy is typically used to insure a loan. For example, a five-year term policy may cover a five-year loan you have taken out from a bank. If you die within five years of the loan, the term policy pays off the balance of the loan. Normally, term policies are used to cover mortgages at 15 or 30 years. Term policies may also be used to insure income during your lifetime. For example, a 30-year term life policy provides inexpensive coverage in the event that you die within those 30 years. If you buy enough life insurance to replace your income, your spouse will not be left without a second household income if you die.
Permanent life insurance provides the same protection as term life insurance, but with premiums that are often higher than term life. The higher premiums cover the cost of extending death benefit coverage to age 100 or higher. The high premiums also provide investment capital for the insurance company and help to build a cash value savings inside of the policy. This cash value savings may be withdrawn or borrowed against for any reason.
During retirement, tax-free withdrawals up to your cost basis (the total amount of premiums you've paid into the policy), as well as tax-free low- or zero-percent-interest policy loans, may be taken against the policy to supplement your retirement income. Policy loans do not have to be repaid during your lifetime.
Warning
-
If you take policy loans against a permanent life insurance policy, you must ensure that the policy does not lapse. If the policy terminates, then all of the policy loans become taxable income to the extent that they exceed your basis in the policy. When purchasing term life insurance, purchase only what you need to insure your financial obligations. Since term life insurance is temporary, excess life insurance represents wasted premium dollars that you will never get back.
Considerations
-
Before using life insurance as a financial tool, consider your purpose for buying life insurance as well as your financial goals. If you need or want only temporary coverage, term life insurance is ideal. If you want or need a personal savings and wish to combine it with your insurance policy, a permanent policy may be the right choice for you. Consult with a financial professional to discuss your exact situation.
-
