Life insurance helps provide a much-needed financial safety net that can help you navigate the various stages of life. Alongside a death benefit to your beneficiaries in case you pass away, some policies build cash value that you can use while still alive. But is life insurance an asset? This article explains in detail whether you can treat life insurance as an asset.
Is life insurance considered an asset?
While the death benefit of a life insurance policy is not an asset, your policy is considered a financial asset if it has a cash value. Generally, permanent policies like whole life and universal life policies can build cash value while term life insurance policies can’t. If you have life insurance coverage or are considering purchasing one, it helps to know how these two types of policies differ and when you can consider your policy a financial asset.
The basics of life insurance
Life insurance is a legally binding contract between you and your insurance provider. Under this contract, you agree to make premium payments in exchange for the insurance company paying your named beneficiaries a specific death benefit when you pass away.
The primary purpose of life insurance is to help protect your family and beneficiaries financially by providing a lump sum payment when you are not there to do so. They can use these funds for any purpose, ranging from paying off mortgages to settling short-term debts like credit card loans.
Generally, life insurance policies fall into two broad categories: permanent life insurance and term life insurance. While permanent life insurance policies cover you for your entire life, term life insurance policies offer protection for a specific period, typically between 10 and 30 years. Term life policies may also be cheaper than permanent policies.
Beyond that, there’s one more significant difference between permanent life insurance and term life insurance: built in cash value. While permanent policies (whole life and universal life policies) can accumulate cash value that earns interest and grows over time, term policies can’t. Fidelity Life offers both permanent and term life insurance policies that you can purchase based on your needs.
Why you should view life insurance as an asset
In the financial sense, an asset is anything of monetary value that you own at any given moment. It can either be a tangible or an intangible asset. Tangible assets are physical and measurable things that you own. Examples include cars, houses, furniture, and electronics. Even gold, when held in its physical form, is a tangible asset.
Intangible assets are things that don’t exist physically but have monetary value. Examples include cash in bank accounts, stocks, investment accounts, retirement accounts, trademarks, patents, and cryptocurrencies. While not all, many intangible assets are also liquid assets, meaning that you can easily and quickly convert them into cash.
The opposite of an asset is a liability, which refers to something you owe or have to pay for. Considering you have to pay premiums on insurance coverage, is life insurance an asset or liability? The answer is that life insurance is an asset as long as it builds cash value, which is the case with permanent insurance policies. However, a life insurance policy may be a liability if it doesn’t have accumulated cash value as is the case with term policies.
Your treatment of life insurance coverage as an asset should be based on its ability to build cash value over time. That’s why in a divorce, your whole life insurance policy may be counted as an asset but a term life policy can’t. Therefore, it’s important to view and treat your permanent life insurance policy as an asset, not just for the sake of understanding divorce proceedings, but also because you can maximize the benefits of the policy as an investment, in estate planning, and as a hedge against market risks.
Understanding the Asset Value of Life Insurance
Permanent life insurance policies can differ from one person to another in terms of coverage amounts and monthly premium rates. However, the one thing that they all have in common is accumulated cash value. This is a secondary benefit of the policy and it can help you in a variety of ways, including liquidity management, managing your tax liability, and investment. But first, it’s essential to understand the components of your policy and how it works.
Components of a life insurance policy
In general, a life insurance policy has two primary components: a premium and a death benefit. Permanent life insurance policies also have cash value accumulation, which term life insurance policies lack.
Premium
In life insurance, a policy premium refers to the amount you will pay for coverage. It’s usually calculated by the insurance company based on factors like your age, gender, health status, lifestyle, and criminal record.
Although many policyholders make premium payments monthly, you can pay yours yearly or as a lump sum. Your coverage will remain in force as long as your premium payments are up to date. If you default on payments, your policy will enter a grace period and eventually lapse.
During the grace period, you can reinstate the policy without any fine by paying the outstanding premium. Although it varies from one insurance company to another, a grace period typically lasts between 30 and 90 days. Some life insurance policies have a provision for reinstating coverage even after the grace period has expired. But you will need to confirm with your insurer if your policy has such a provision. Otherwise, failure to pay your policy premiums may lapse the policy and your beneficiaries will likely not get any death benefits.
Cash Value Accumulation
With a permanent life insurance policy, part of the premiums you pay go to a tax deferred savings account that earns interest and grows over time. This money is called cash value and it’s usually accessible to you as living benefits.
Living benefits refer to the perks you get from your life insurance policy when you are still alive. If your policy has living benefits, you can either withdraw the accumulated cash value from it or use that cash value as collateral for securing a loan. Whatever the case, this cash value accumulation is what makes a permanent insurance policy an asset.
It’s worth noting that different types of permanent life insurance policies have different ways of building cash value:
- Whole life: With a whole life insurance policy, your premiums typically stay the same throughout the coverage period. A portion of the policy premiums goes to cash value accumulation while the rest goes to the policy’s death benefit. When issuing the policy, the insurer usually guarantees that you will get both a death benefit and cash value. This is what makes whole life policies good for building wealth and protecting your death benefits simultaneously.
- Universal life: A universal life insurance policy offers a flexible way of paying premiums. Instead of paying the same amount every month, you can increase or decrease your policy premium. It has both a death benefit and cash value which increase or decrease based on your premium payments. Some universal life policies are indexed, meaning their performance mimics the stock market.
- Variable life: Variable life insurance policies let you decide which mutual funds to invest your cash value in. These policies don’t guarantee returns, which means you may lose money if your chosen funds perform poorly.
Death Benefit Protection
A death benefit is the amount of money your life insurance company will pay out to your beneficiaries if you die when the policy is in force; that is when your premium payments are up to date. Usually, any debts you owe at your time of passing must be paid off first before your remaining assets are distributed to your heirs. But since death benefits are not assets, your insurance payout can’t be used to settle the debts you owe. That means your beneficiaries will receive the full death benefit. Since it’s essentially “untouchable”, a death benefit is the primary purpose for taking out life insurance coverage.
Is term life insurance an asset?
Considering it doesn’t have a cash value component, is a term life insurance policy considered an asset? No, term life insurance is not an asset because it doesn’t have built in cash value. However, in some very rare cases, the proceeds of your term life policy can become a liquid asset. These cases include:
- If you sell your term policy for a profit. The profit you make from the sale is considered an asset and is subject to income tax.
- If your total value of assets reaches or exceeds $13.61 million. Your beneficiaries may have to pay a gift or estate tax if the total value of their inheritance – including death benefits from your term life policy – total or exceed $13.61 million. This is the current threshold for estate tax.1
Strategies for Using Life Insurance as an Asset
Cash value life insurance policies earn tax-deferred interest on premium payments. There are a few options on how to use such a policy as an asset:
Building Cash Value Through Premium Payments
When you make premium payments on a permanent insurance policy, some of the money goes towards death benefits while the remaining goes into cash value, which increases as you pay more premiums.
While all permanent life policies are good for building wealth through premiums, universal life insurance policies are particularly great because they allow you to increase premiums and accumulate cash value and interest even faster.
Typically, you can use the money earned by a cash value life insurance policy to pay premiums, thus eliminating the need to pay out-of-pocket. This handy feature may be a lifesaver when you don’t have the money to pay a premium and don’t want your policy to lapse. Bear in mind that if you use up the cash value of your permanent policy on premiums, the policy will slip into a grace period and lapse thereafter if you don’t cover the outstanding premium.
Accessing Cash Value Through Policy Loans or Withdrawals
Depending on how your permanent policy is structured, its cash value can provide living benefits – perks that you access while you are alive. One way of accessing this cash value is by withdrawing cash from the policy. But this affects the policy’s death benefit.
The other way of accessing a permanent policy’s cash value is by getting a policy loan. This is where you obtain a loan from your insurance company using your policy’s cash value as security. Policy loans generally don’t have an impact on coverage when you repay them. However, if you pass away with a loan balance, the insurance company deducts that balance from the death benefit. The remaining cash value goes to the insurer while your beneficiaries get the remaining death benefit.
Using Life Insurance as Collateral for Loans
You can use a permanent life insurance policy as security to obtain a loan from a lender that’s not your insurance company. This is called collateral assignment of a life insurance policy. In this case, your life insurance policy is essentially serving as an asset that you can borrow a loan against.
As is the case with a policy loan, the collateral assignment of a policy doesn’t affect its death benefit if you repay the loan. However, if you pass away with an outstanding balance, the lender will tap into your policy’s death benefit to recover their funds. The policy’s cash value remains with the insurance provider while your beneficiaries get the remaining death benefit.
Incorporating Life Insurance into Estate Planning
Permanent life policies are excellent tools for estate planning and leaving a legacy. This is particularly the case with whole life insurance policies because they guarantee returns. You basically use premium contributions and tax deferred interests to build cash value and wealth over time. The accumulated wealth is then transferred to your beneficiaries when you pass away. You can even decide beforehand how it should be split between various beneficiaries.
With the right strategy, you can apply for a high coverage amount in your policy (if you have a high net worth) to help protect your wealth. You may use some of the cash value to pay off debts so that tangible assets like property remain intact for your beneficiaries. The insurance company retains any remaining cash value while your beneficiaries get the policy’s full death benefit along with your accumulated wealth.
Benefits of Viewing Life Insurance as an Asset
When viewed as an asset, life insurance brings multiple benefits to the table. For one, it gives you the motivation to keep up with premium payments because you are investing in an asset that will protect your loved ones in your absence. This comes with the added advantage of peace of mind. Below are more benefits of viewing life insurance as an asset:
Tax Advantages of Cash Value Growth
Every premium payment that you make towards your permanent life insurance policy builds cash value and earns interest on a tax deferred basis. This tax exception on earnings doesn’t apply to many other common investment vehicles like dividends and capital gains.
Besides, payouts from life insurance policies are not considered taxable income unless they take the estate’s total value to $13.61 million or more.1 Therefore, your beneficiaries can get tax free death benefits from your policy, unlike things like property, which are taxed.
Protection Against Market Volatility
Permanent life insurance policies have a built-in investment feature. The cash value you build can help you put money into conservative investment vehicles like exchange-traded funds (ETFs) and mutual funds, which offer protection against market volatility.
Whole life insurance policies have an edge on this because they guarantee returns. Variable life and universal life policies can be risky because they don’t guarantee returns. You may want to talk to a licensed insurance agent or financial advisor before choosing a life insurance policy, especially if you want to use it for investment.
Supplemental Income Source in Retirement
Since you can tap into the cash value of a variable, universal, or whole life insurance policy, it’s possible to use the policy as a source of funds when you retire, should you need to. Some policies have an accelerated benefits option which allows you to receive a portion of the death benefit of the policy while you are living. Many insurers will let you withdraw between 25% and 100% of the policy’s value.
That said, withdrawing 100% of your policy’s value means surrendering the policy. To surrender a life insurance policy means taking back all the premium contributions you made less any fees and fines that the insurer charges for a cash surrender. Your coverage, along with the death benefit, also ends when you cash out an insurance policy.
Preservation of Wealth and Legacy Planning
A life insurance policy protects the premium you contribute along with the cash value and tax deferred interest that it accumulates. It’s a great way of building wealth because cash value gives you access to credit that you can use for good investments. When you pass away, the investments and tax free death benefits will be transferred to your beneficiaries. If you have a universal life or whole life policy, you can overfund it to make it a life insurance retirement plan (LIRP) that will hold and preserve most of your wealth until it’s transferred to your chosen beneficiaries.
Factors to Consider Before Using Life Insurance as an Asset
Life insurance is a long-term – possibly lifelong – investment. That’s why it’s essential to structure it right from the outset, particularly if you intend to use it as an asset. Below are some things to keep in mind:
Policy Type and Features
Not all life insurance policies can be used as assets. Only permanent life insurance policies, which include variable life, universal life, and whole life insurance policies have a cash value feature that can be considered an asset. Therefore, if you want a policy that you can use as an asset, you may want to consider permanent policies over term policies. You may also want to look for a policy that’s structured to guarantee returns. While whole life insurance policies guarantee returns, variable life and universal life policies don’t.
Cash Value Growth Potential
It’s possible for the returns of a life insurance policy to be lower than other investment options, even for a whole life policy. If you are not sure what to expect, talk to an investment expert who can guide you on the potential returns of various investment vehicles. The last thing you want to do is tie up most of your funds in a policy that’s not growing because of a low interest rate when you can look at other investments like stocks or similar tax-free plans like a 401(k) or IRA.
Surrender Charges and Fees
High surrender fees on a life insurance policy usually affect its overall return. Generally, if you surrender a life insurance policy you may lose between 10% and 40% of its value to surrender fees. If you are not already covered, make sure to shop around for an insurance provider who combines affordable premium rates with low charges.
Impact on Death Benefit and Policy Coverage
The primary purpose of a life insurance policy is to provide a death benefit to beneficiaries. If it’s structured such that using it as an asset can impact coverage and death benefit, then you are better off considering other investments for returns. Read your policy’s fine print to know what happens if you use it as an asset.
Considerations for Maximizing Asset Value
Adding a life insurance policy to your investment portfolio only makes sense if you can maximize its value. That means the death benefit remains intact and returns exceed potential fees – especially if you intend to draw cash from the policy. There are things you can do to maximize the asset value of a life insurance policy:
Review Policy Performance and Adjust Strategies
Regularly check the rate of return on investment that you are getting from your policy. In case it’s underperforming, you might want to consider switching to a new strategy or check if there are alternative investments that can yield more.
Working with Financial Advisors and Insurance Professionals
Consider talking to a life insurance or investment adviser about whether having a life insurance policy in your investment portfolio is a good move. You can speak with a licensed life insurance agent at Fidelity Life for help with questions or to get an online quote by calling 1-855-977-5607.
Regularly Assessing Financial Goals and Needs
Ultimately, make sure your life insurance policy still meets the original financial goals you intended it to. For many people, that goal is providing coverage to beneficiaries. If using it as an asset compromises this goal, perhaps it’s better to reconsider.
Article Sources:
- IRS.gov. “Estate Tax, https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax”
