Let’s dive into the different types of life insurance policies and determine how each could qualify as an asset
Life insurance is a topic many people don’t want to think about, but any insurance agent or financial advisor will tell you it is vital to your family’s financial security.
It should absolutely be included in your investment portfolio and estate planning.
Life insurance at first glance is a way to ensure that burial expenses and other debts are covered at a time of loss; however, it can be much more, and often times it is much more. Depending on the type of policy you have, it could be considered a financial asset.
WHAT IS AN ASSET?
Before we begin, let’s pause and talk about assets. An asset is an item with present or future value that is owned by an individual, household, couple, or a family. Even a business can own assets.
There are two types of assets: liquid assets and fixed assets.
Liquid financial assets convert to cash much easier and quicker than fixed assets.
Common examples of liquid assets are: cash, stocks, bonds, mutual funds, checking and savings accounts, money market accounts, certificate of deposits, and life insurance policies with cash value.
Fixed assets include annuities, real estate, retirement savings, and personal property (jewelry, household furnishings, boats, vehicles, etc.). Courtesy of NerdWallet
Now that we have established what an asset is and which are fixed and which are liquid assets, let’s discuss the main types of insurance to see which qualifies as an asset.
2 MAIN TYPES OF LIFE INSURANCE
A term life insurance policy is good for a specified period of time; 5 years, 10 years, up to 30 years. Term, or temporary, is not permanent.
Term policies are the simplest and least expensive form of life insurance. It’s only function is to pay a death benefit if you die during a specified time frame.
The other, more expensive type of life insurance is permanent or whole life insurance policies. This policy provides a lifetime of coverage and has the ability to grow cash value.
Permanent policies, or whole life, cover the insured for life. Permanent policies are more complex. They are considered a financial product because of how it gains value over time.
Let’s compare term and permanent life insurance policies based on price, length of coverage, premiums, death benefits, and cash value.
- Price – Term policies are much more affordable than whole life, especially when you consider higher coverage amounts that may be needed for income replacement. The lower premiums associated with term life insurance make it very attractive.
- Length of Coverage – The term in which your policy is in effect can be as little as one year up to 30 years. While the insurance is considered temporary, many policies will give you the option for renewal without a medical exam. There are also convertible term life insurance policies that give you the option to convert to a whole life policy. It is important to read the fine print on your policy in order to make an informed decision on the future of your coverage when the time comes.
- Premiums – Once the policy is in effect, the premiums are fixed until the policy’s term has ended or is renewed. Keep in mind, the older you are when your policy begins or renews, the higher your premiums will be. It’s common that term policy offer the guaranteed renewable option. Regardless of your health status when your term policy expires, if you’re willing to pay the new premium for your age, the term life insurance will renew. This is excellent if you’re on your death bed, or if you’ve become uninsurable due to not being in good health.
- Death benefit – The policy’s death benefit is guaranteed as long as the premium payments are made, preventing the policy from lapsing.
- Cash value – Term policies do not have cash value and therefore do not produce any return on your investment (premiums). These policies are specifically for a death benefit to be paid if death occurs during the policies term.
- Price – Permanent policies consist of both premium and a savings component, which creates a higher premium. Of course, the younger the insured is at the point of purchase, the lower the premium will be. However, when compared to term insurance, term will give you a higher death benefit for the money, but it’s time sensitive.
- Length of coverage – Coverage with permanent insurance is for life so long as there is not a policy lapse due to unpaid premiums. Numerous whole life insurance companies pay the death benefit once the insured reaches the age of 121.
- Premiums – Depending on the type of permanent plan you have, your premium can be a fixed payment amount or it may be variable. Policies with flexible premiums usually include at attachment to the stock market.
- Death benefit – Death benefit amounts can fluctuate depending on the type of whole life policy you purchase.
- Cash value – Cash value accumulates with permanent life insurance. There are even times when an insured can stop making premium payments and allow the cash value to fund the life policy.
Each type of policy has its own advantages; therefore, deciding which one to purchase depends on how much death benefit you need, how long you’ll need it, and how much you can afford. Some individuals might even find that having both a term and permanent policy works best. In other cases, a person’s medical history or health condition might make term life insurance their best or only option.
My personal life insurance policy is whole life with a term rider. This gives me more death benefit until I reach an age where my family may not need as much life insurance on me. –Nick Gann
LIFE INSURANCE AS AN ASSET
When considering life insurance as an asset class, the cash value component makes the difference. Since term life policies do not have any cash value, they are not considered an asset. They have zero financial value unless you pass away during the policy term.
Permanent life insurance, with its cash value accumulation, is considered an asset. Some permanent policies are designed to provide more cash value than others. If you are considering a life insurance policy based solely upon its value to you as an asset, you will want to make sure you pick a policy that focuses more on increasing cash value instead of the death benefit.
Now that we understand how some life insurance policies can be considered an asset, let’s talk more about the variety of permanent insurance plans.
TYPES OF PERMANENT WHOLE LIFE INSURANCE
Whole life insurance is the most common permanent policy purchased. Whole life comes with fixed premiums for the life of the insured and will increase in cash value as payments are made. Thus, a whole life policy is often referred to as cash value life insurance.
A whole life insurance policy is considered the least risky of all life insurance plans.
Universal life insurance provides cash value and gives you the ability to have flexible premiums if needed. The idea behind universal life is that it gives you the opportunity for your cash value to cover your premiums. Paying your life insurance premiums with cash value will ultimately lower your total available cash value; otherwise, you would have to lower the death benefit to reduce your premiums.
Additionally, your insurance company will invest the cash value portion of your universal life insurance policy in order to earn interest. Therefore, the cash value growth is oftentimes dependent upon the interest rates of the company’s investments.
Variable life insurance provides lifetime coverage with cash value that can be invested in securities (mutual funds). The owner of the policy typically has an opportunity to select what type of fund the cash value is invested. Again, whenever cash value is invested to obtain a higher rate of return, there is more risk involved. These policies are more appealing to those wanting to invest their cash value since they have control over where their monies are being invested.
Variable universal life insurance is variable and universal policies rolled into one. You have the investment opportunity of the cash value into funds of your own discretion and the ability to have flexible premiums and a flexible death benefit.
WHO CAN SELL PERMANENT WHOLE LIFE INSURANCE?
Because some permanent life insurance policies include a portion of funds (cash value) invested in securities, you might think that a financial advisor could sell such policies. However, a person must have a life insurance license to sell life insurance policies. Additionally, in order to sell Variable Universal Life insurance, the agent must also hold a securities license.
BENEFITS OF LIFE INSURANCE AS AN ASSET?
There are several advantages to being a policy owner of permanent life insurance that allows for cash value growth.
- Automatic savings. The accumulated cash value allows for a person to save money. You also have the ability to withdraw from it and pay it back if you choose. Cash value accumulation is a phenomenal whole life insurance benefit.
- An asset that can be used to secure additional assets. Lenders will typically allow the cash value of the policy to be used as reserves or for collateral on a loan. Depending on your financial situation, this may make securing a loan easier.
- You can borrow against it. If you need a loan for any reason, you can borrow against the policy’s cash value. Additionally, you won’t have to pay any taxes for the policy loan as long as your coverage is still in effect. There is interest on this type of policy loan.
- Increases your net worth. Since permanent life insurance policies are considered an asset, they are considered in valuing your net worth.
TAXES ON LIFE INSURANCE
One of the appealing qualities of life insurance is that the cash values and death benefits are not taxed. However, if funds from the policy are accessed prior to the insured’s death, then taxes may apply to any net gains. It all depends on whether the money you are accessing has been taxed before. If you are accessing money that is from the payment of premiums, money you have already been taxed on, then this money is not taxable income.
However, if you access money that has come from investment gains or interest, then you will be paying taxes on those monies. Your life insurance company will be able to tell you the amount of money you have in your policy basis if you want to avoid touching the taxable growth.
If you borrow against the cash value of your policy, it is tax-free. This is considered a loan, and we don’t pay taxes on loans.
It is important to note if the life insurance death benefit goes to an estate, it can be subject to estate taxes. To avoid a decrease in your death benefit due to taxes, name a beneficiary and contingent beneficiary rather than naming an estate on your policy and be sure to keep them up to date.
LIFE INSURANCE FOR LONG TERM CARE
Some policies have an early access option, a rider that allows the insured person to access some or all of the life insurance proceeds to help cover long-term care or end-of-life care expenses. You may even be able to transfer money from your life policy to purchase long term care insurance. While this can be an extremely helpful benefit, any money you receive will reduce the death benefit.
As with any big financial decision, it’s important to do your homework and understand how life insurance can be a valuable asset for your investment portfolio.
What type of insurance policy interests you?
What level of risk are you comfortable with?
What are your investment goals?
What do you want to get out of a life insurance policy?
Is there a life policy that compliments your current financial plan?
Having a knowledgeable agent that you can trust is key. Your agent should take the time to discuss your financial portfolio and goals for life insurance in order to help you explore the different options and find the policy that works for you.
Finally, don’t delay! It may not be your favorite topic to think about, but it will give you and your family peace of mind. Additionally, securing a policy in your early years will be more affordable no matter which type of policy you choose.