Life Insurance as an Asset

Using life insurance to build, protect, and transfer wealth

For high-net-worth families and individuals, life insurance can provide benefits that go beyond income replacement to support beneficiaries upon the death of the insured. As part of a comprehensive wealth management plan, life insurance can provide liquidity to cover estate taxes, equalize inheritances among beneficiaries, maximize wealth, secure a legacy, and allow beneficiaries to retain ownership of important assets, such as the family businesses or real estate.

The following looks at life insurance and how some life products can provide solutions for things such as retirement planning, funding long-term care needs, and wealth accumulation and transfer. We’ll also review the various tax advantages of life insurance and how recent changes in new tax codes could bring higher savings opportunities for permanent life insurance policyholders.

Is life insurance considered an asset?

Financial assets such as a home, investments, and retirement accounts are designed to appreciate and gain value over time. Depending on the type of life insurance policy and how it is used, permanent life insurance can be considered a financial asset because of its ability to build cash value or be converted into cash. Simply put, most permanent life insurance policies have the ability to build cash value over time. As a result, the accumulated cash value can be considered an asset when calculating one’s net worth.

The primary purpose of life insurance is to provide financial support to your loved ones upon your death. However, permanent life insurance can also offer many of the benefits similar to typical long-term investments such as IRAs and mutual funds, providing options when building a diversified wealth management portfolio. Permanent life insurance can also be an asset for hedging against market risk.

Types of asset-generating permanent life insurance

There are several types of permanent life insurance products that can provide financial security for beneficiaries as well as act as a type of savings vehicle. Here, we’ll look at the different types of asset-building life insurance products and how they work.

Whole life insurance

Whole life (WL) is a type of permanent life insurance. In addition to a death benefit, WL insurance has the potential to accumulate cash value over the lifetime of the policy by taking a portion of the premium paid and allocating it to a cash value account.

Over time, funds in the account grow tax-deferred and can be borrowed by the policy owner while he or she is still living by way of a policy loan or cash withdrawal. Because the interest, dividends, or capital gains from the cash value aren’t subject to taxes, this makes whole life insurance a popular asset-building tool. Keep in mind, however, that borrowing from the policy will also decrease the amount of the payment to beneficiaries if it is not paid back prior to the death of the policy owner, and any interest charged for the loan will also need to be paid when paying back the loan.

Universal and variable universal life insurance

Similar to WL, a universal life (UL) insurance policy has the potential to build cash value by accruing interest over time that can be borrowed while the policyholder is still alive. The primary difference, however, is that a UL policy allows greater flexibility than a WL policy regarding premiums and death benefits. A variable universal life (VUL) insurance policy goes a step further in that it allows the policyholder to invest any interest earned in sub-accounts (similar to mutual funds), for even greater asset growth potential. Both UL and VUL allow any cash value accrued to grow on a tax-deferred basis.

Hybrid life/long-term care insurance

With traditional long-term care insurance (LTCI) policies, coverage that isn’t used for care during the insured’s lifetime is ultimately lost. Hybrid life insurance products (also known as asset-based long-term care), however, provide the perfect balance of long-term care coverage if there is a need or a death benefit if the policy isn’t utilized to help pay for long-term care expenses.

There’s no denying that the high costs of long-term care can wipe out savings set aside for things such as retirement, not to mention becoming a financial burden on loved ones who must cover the costs of care. By providing coverage, when needed, and a death benefit, a hybrid life policy and an LTCI policy can be an asset in protecting wealth.

Considerations for using life insurance as part of a strategic wealth management plan

In retirement

Life insurance provides the ones you love with a tax-free death benefit upon your death. When properly designed and funded, permanent life insurance can also be an asset for enhancing retirement income in a tax-advantaged vehicle, providing an additional stream of income if needed.

The cash value inside a permanent life insurance policy grows tax-deferred, providing an option to build assets in a tax-favorable manner. It also provides flexibility to access the policy’s cash value with tax-favored distributions. Simply stated, it allows you to tap into potential cash value by way of tax-favored loans and withdrawals. For individuals who have maxed out their retirement contributions beyond the limits of traditional qualified retirement plans, this can be a viable solution for helping to supplement income in retirement, but a loan will also reduce the value of the insurance policy by the amount of the outstanding loan and any amount borrowed exceeding the cash value will be taxed because those funds are investment gains.

For estate planning

Above certain amounts, the U.S. government imposes an estate tax on the transfer of property upon death. In addition, many states impose a state-level estate or inheritance tax. These taxes must be paid soon after death. For high-net-worth individuals with assets such as a business or real estate, it isn’t always possible or practical for beneficiaries to quickly sell and transform these illiquid assets into cash. Life insurance is an asset that can provide immediate estate liquidity to help cover estate taxes.

Another estate planning benefit that permanent life insurance can provide centers on estate equalization and distribution. When determining how much heirs will receive and what form the inheritance will take, life insurance can help by dividing assets equally among heirs.

Maximizing wealth transfer

Permanent life insurance is an efficient way to maximize the distribution of assets to a spouse, child, or charity. Combined with the protection of a will or trust, life insurance can help increase the amount you pass onto heirs and organizations. In addition, if you anticipate that income and estate taxes will substantially increase in the near future, permanent life insurance will allow you to transfer wealth into a shelter that protects your assets from higher taxation.

Improved asset stabilization

Poor market performance could substantially reduce an inheritance earmarked for loved ones. By directing a small percent of your net worth or income each year into a life insurance policy, you can better hedge against an underperforming market, stabilizing wealth and passing more assets to beneficiaries in a tax-efficient way. Over time, the leverage offered by life insurance may be reduced as the non-life insurance assets grow and compound.

Funding long-term care needs

In addition to helping fund long-term care costs with a hybrid life/LTCI policy, the accelerated death benefit rider included in some life insurance policies will allow you to receive a tax-free advance on your life insurance death benefit while you are still alive. Depending on the type of policy you have, you may be able to receive an advance on your life insurance policy’s death benefit if you are deemed terminally ill, have a life-threatening diagnosis, are permanently confined to a nursing home and are incapable of performing two of the six activities of daily living, or if you need long-term care services for an extended amount of time. In addition, some permanent life insurance policies offer an optional LTCI rider that allows you to set aside accumulated assets in the policy — essentially self-insuring your future long-term care needs.

Preserving assets: The tax benefits of permanent life insurance

A well-designed tax planning strategy should help reduce taxes while you are alive and after your death. Permanent life insurance can be an effective tool for helping to solve specific tax-related challenges.

Income taxes and retirement

In retirement, you’ll draw income from a number of investment accounts that are either fully or partially taxed. A mix of permanent life insurance, along with other investment accounts, allows you to take tax-free loans from the cash value in your policy to help supplement your income, preserving assets and minimizing taxes. However, this will also lower the amount of the life insurance benefit once the policy owner dies.

Once retired, you’ll also be drawing non-discretionary income from Social Security and taking required distributions from taxable retirement funds. As income from Social Security fills your lower income tax brackets, you can better minimize taxes by drawing income that you need from the cash value in your life insurance policy, generally tax-free. However, this will also lower the amount of the life insurance benefit once the policy owner dies.  

Income taxes and Social Security benefits

If you have a substantial income such as interest, dividends, and other taxable income that must be reported on your tax return in addition to your Social Security benefits, you’ll be subject to federal income taxes on 85% of your benefits. The fact is, most all taxable income, including tax-free municipal bond interest, is taken into account when determining just how much of your Social Security benefits the IRS will take. With permanent life insurance, the assets inside your policy won’t increase the tax on your Social Security income.

Recent changes to IRS tax code Section 7702 and the impact on life insurance

Section 7702 of the U.S. IRS tax code was created to differentiate between life insurance policies and investment vehicles imitating life insurance contracts. The section’s objective is to ensure that only legitimate life insurance policies receive tax-advantaged treatment. Simply stated, it is used to determine whether a life insurance contract qualifies for tax benefits and how proceeds are taxed. Proceeds of policies that don’t meet the government’s definition of a true life insurance policy will be considered taxable as ordinary income and subject to annual taxation — whether you withdraw money from your policy or not.

Recently, the economy’s low-interest environment has prompted positive changes to Section 7702, allowing consumers to put even more money into a permanent life insurance policy. For those using permanent life insurance as an asset-building strategy for the future, Section 7702 allows them to effectively transform policies into retirement vehicles, in addition to, and sometimes instead of, an income-replacement vehicle. For high-net-worth individuals who aren’t as concerned with the death benefit provided by a life insurance policy, having the ability to put more money into these types of contracts provides greater access to the tax-advantaged cash value within the policy.

Conclusion

Life insurance can be a valuable asset in the building, protecting and transferring of wealth as part of your overall wealth management strategy. If you’re considering how permanent life insurance fits in your financial portfolio as a tool for meeting your wealth management goals and objectives, your relationship manager^† is here to help.

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At The Private Bank, we believe that managing wealth goes beyond providing financial services. It’s about helping our clients focus on living more fulfilling lives by contributing ideas and innovation that can make it possible for them to achieve their financial goals.