Written by: Guest | Best Company Editorial Team
Last Updated: July 1st, 2020
Guest Post by Schimri Yoyo
If you had a penny and I offered to trade you a ten-dollar bill for that penny, would you accept my terms?
Of course, you would.
What if I offered you that same exact trade, your penny for my ten-dollar bill, but with this one caveat: you can choose to spend the ten dollars on anyone you like but you can’t spend it on yourself.
Would you still make that trade?
You probably would still make that deal and you would probably think long and hard about on whom you would spend the money. In essence, that’s how life insurance works. Or at least, that’s the extent of how most people understand how life insurance works.
A customer purchases a policy for a penny and when he or she dies, his or her beneficiary (or beneficiaries) receive ten dollars of proceeds from that policy. The owner makes a small investment, but is unable to benefit from that investment; only the selected person(s) will receive the substantially larger return of that investment.
However, that is only how some insurance policies work (typically, any term policy). Did you know there a certain life insurance policies that offer living benefits that their owners can take advantage of while they are still alive?
Permanent life insurance policies — usually a whole life or universal life policy — can build cash value that grows tax-deferred and can be accessed tax-free to supplement income. There are three aspects of cash-value life insurance: Premium Payments, Death Benefit, and Cash Value.
- Premium Payments — You’re actually purchasing the death benefit when you make premium payments. Many insurance companies offer you the choice of paying monthly, quarterly, semi-annually, or annually. The insurance company deducts charges from your premium payments for mortality (to fund the death benefit) and other expenses. The remainder of your payment builds cash value tax-deferred as the accumulation portion of the life insurance policy.
- Death Benefit — Permanent life insurance, as long as it remains in-force, can provide a tax-free death benefit to the beneficiaries of your policy. The proceeds of the policy pass directly to your beneficiaries so they can avoid estate administration process delays.
- Cash Value — Cash value that builds in a life insurance policy can be an important source of back-up funds. Your policy’s cash value can be a guilt-free reserve of capital to finance the happenings of life. Whether going on a family vacation or replacing an old washing machine or paying for a wedding, you can access the cash value of your policy income-tax-free (through withdrawals and policy loans).
These life insurance policies can be used in a strategy known as LIRP (Life Insurance Retirement Plan) or LIFT (Life Insurance as a Financial Tool). If you haven't heard of these, don’t be ashamed or embarrassed. In the past, LIRPs/LIFTs have mainly been presented to people with a high net worth or in higher tax brackets. But people with middle-class incomes can use a LIRP (or LIFT) to prepare for a more manageable and enriching retirement as well.
Pamela Yellen, financial consultant and founder of Bank On Yourself, says “A LIRP is ideal for anyone who wants to avoid the restrictions common to traditional retirement plans, and is concerned about market volatility and wants guaranteed, predictable growth, and to avoid losing money in a market crash. . . . People who tend to live above their means and don't have patience or self-discipline should avoid LIRPs, as they are a long-term strategy.”
These policies usually work best for people who have a time horizon of 15 years or more before needing access to the funds.
But when and how should LIRPs/LIFTs be used?
Questions to consider
- Do you have significant savings or a good portion of your investments in taxable accounts?
- Do you want to provide your family or beneficiaries with a tax-free benefit if you die?
- Do you desire to leave a financial legacy?
- Do you want to build cash value for financial flexibility in the future?
If you answered “yes” to any or all of these questions, then you may consider investing in a LIRP/LIFT strategy. And during your considerations, you should think in terms of these key phases of investment: Accumulation, Distribution, and Legacy.
Your twenties and thirties — When you’re first entering the workforce or starting your career, money may be tight. How would your family replace your income and pay the bills if you die? While buying life insurance is primarily about protecting your loved ones in your absence, the cost of insuring your life will never be lower; thus, it’s a good idea to start building cash value now. Paying more premium in your 20s and 30s will improve your potential for cash value growth for later in life.
Key concerns: Protection for your family. Replace lost income.
Your thirties and forties — In your thirties and forties, your income may have increased, but your responsibilities and your liabilities have probably increased as well. Your family might be larger and you might have a mortgage, a car loan, and other obligations to protect. Unexpected events could devastate your wallet.
Key concerns: Protection for your family. Replace lost income. Cash savings for emergencies or other opportunities.
Your forties and fifties — As you approach your late forties and into your fifties, you’re likely thinking more about retirement, and wondering if you’ve been saving enough. A little extra money in your life insurance policy can provide better protection and will continue to grow tax-deferred.
Key concerns: Protection for your family. Replace lost income. Cash savings for emergencies, other opportunities, and supplemental retirement income.
Your sixties and beyond — When you have reached retirement age in your sixties, you can supplement that retirement with tax-advantaged access to the cash value. You can take out all the money you put in — tax-free — and you can borrow against the policy for even more money. This can lower your effective tax rate by easing the draw on your taxable retirement income sources. When you die, your life insurance death benefit goes to your beneficiaries tax-free, which they can use to cover living expenses and other debt.
Key concerns: Protection for your family. Replace lost income. Cash savings for supplemental retirement income. Maximizing assets and transferring them to beneficiaries in tax-efficient ways.
The bottom line
As you can see, permanent life insurance is a very versatile tool that can offer a variety of living benefits for the policy owner to take advantage of. You should contact a financial professional to discuss which policy and strategy might be suitable for you and your family.
Schimri Yoyo is a writer for 360 Quote LLC and a financial advisor with active life and health insurance licenses. Yoyo is a proud graduate of Arcadia University, having earned both a Masters in Special Education and an MFA in Creative Writing from the castle-riddled campus in Glenside, PA. By personality and by profession, Schimri is an educator and a storyteller who is eager to assist individuals and families to craft and complete their own financial success stories.