6 Things You Didn't Know Life Insurance Could Do
Reading time: 4 Minutes
By Ilana Polyak
January 7th, 2020
What's the point of life insurance? The obvious answer is that it provides much needed financial protection for your family and loved ones in the event of your death. A term life insurance policy is a cost-effective way to achieve that important goal for a specific number of years, usually between five and 30.
But did you know that life insurance can do so much more? Permanent life insurance gives you all the benefits of term life insurance with some added features that can give you financial flexibility and help you build wealth.
First, unlike term life insurance, permanent life insurance stays in place as long as you pay the premium, which could be for the rest of your life. It also allows a portion of your premium to go toward a cash value account that grows tax-free. Once your account has built up equity, you can borrow against it or make withdrawals. You can even use the cash value to pay your life insurance premium.
Here are a few useful things you can do with permanent life insurance that you may not have thought about.
1. Provide retirement income
It's no secret that retirement is expensive. While Social Security provides some income, many people—particularly high earners—will need significantly more to maintain their lifestyle. Along with retirement savings and brokerage accounts, permanent life insurance can be a source of retirement income.
You can borrow against the cash value of your policy, and then have the loan and interest repaid from the death benefit after you die. Another option is to convert your policy to a life annuity, by surrendering the death benefit of your permanent life insurance in exchange for regular payments that will typically last the rest of your life. This will give you a guaranteed source of income to rely on, however long you live.You won't have to pay taxes when you do this conversion, but will be taxed on the portion of the withdrawal that is above your original premium payments.
2. Reduce long-term health care costs
Medical debt is among the top reasons for bankruptcy. Permanent life insurance policies (and some term life insurance) allow policyholders to take a portion of their death benefit while they are still alive if they have a terminal diagnosis or a chronic, debilitating illness. Bear in mind that using the accelerated death benefit will reduce the amount of money your heirs will receive.
3. Pay estate taxes, and simplify asset sharing
The death benefit of a life insurance policy isn't subject to income tax. However, it does get figured into your taxable estate. The death benefit will be added to your gross estate and any amount over $11.4 million is subject to federal estate tax (anything over $5.49 million will be subject to Hawaii estate taxes).
Fortunately, your heirs can use the proceeds of a life insurance policy to help pay off estate taxes, which can be especially useful if the bulk of your estate resides in non-liquid assets such as real estate or a closely held business. Life insurance proceeds can provide much needed liquidity right when it's most needed.
The death benefit can also help your heirs avoid having to sell a piece of real estate or business that has been left to more than one beneficiary. The term here is called estate equalization, meaning that the extra cash from your life insurance benefit can be used to equalize or pay off the other heirs so that the property/business doesn't need to be liquidated in order to split it equally.
4. Care for a special needs child
Most parents expect to be financially responsible for their children for roughly 20 years, until their children finish college and become financially independent. But parents of special needs children often face a much longer time horizon—one that can last well beyond their own lifetimes.
The death benefit of a permanent life insurance policy can be used to pay for your child's care after you are gone, by setting up a special needs trust that will allow your child to receive assets while still remaining eligible for needs-based government benefits. Then simply designate that trust as the beneficiary of your insurance policy, and you will have ensured your child's future.
5. Pay for college with more flexibility
With the average annual tuition, room and board and fees at a public four-year college now costing $21,370 (and $48,510 at private universities), it's no wonder parents are looking for savings strategies to help them with this major expense. 529 college savings accounts are often seen as the go-to vehicle for this purpose, but they do have restrictions on what you can withdraw funds for without penalty. You can only use the money from these accounts for qualified educational expenses. Otherwise you will have to pay tax and a 10-percent penalty. Examples of expenses that don't qualify: insurance payments, electronics and smart phones, transportation/travel costs, gym memberships, student loan repayments and any room-and-board costs above what the school's housing would be.
Withdrawals from the cash value of your life insurance, on the other hand, can be used for any purpose without penalty.
Also, the cash value in a life insurance policy is not generally included in financial aid formulas, meaning you can save up money for your child without it counting against the asset limits of needs-based financial aid.
If you'd prefer to borrow against the cash value of your policy rather than simply withdraw money, that can be a good strategy, as well.
6. Give to your favorite charity
Using permanent life insurance for charitable giving allows you to make a larger financial gift to a charity than you might be able to if you were relying on your current cash flow alone. Using this strategy, you can assign the charity as the policy's beneficiary. The charity would receive the death benefit (or some portion of it) at the time of your death.
Even though you designate a charity as your beneficiary, you continue as the policy's owner and have the same access to the cash value as you did before.
As you can see, when it comes to permanent life insurance, there are a broad range of ways you can leverage its cash value to accomplish important life goals. To learn more about these and other possible uses for life insurance, you'll want to meet with your financial advisor to get advice that's tailored to your specific circumstances.
Ilana Polyak is a financial writer who specializes in investing, retirement, college funding, taxes, credit cards and insurance for consumers.
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