How to Use Life Insurance as an Asset

Is Life Insurance an Asset?

Your life insurance policy can only be considered as an ‘asset’ if you can use it during your lifetime. That way, only the cash value on your permanent life insurance policy should be referred to as an asset. After accumulating a substantial value, which may take many years depending on how cash value is invested across the policy types, you can withdraw funds or borrow a loan against the cash value as collateral.

Term policies are designed purely for protection, so they don't include a cash value component. The death benefit paid to your family after you pass away should not be considered an asset while you’re alive.

Which Types of Life Insurance Count as Financial Assets?

Not only life insurance policies can function as a financial asset. Only permanent life policies count as assets, and only if they have accumulated cash value. Here are some types:

• Whole Life Insurance: Accumulates cash value at a fixed rate with stable premiums. If it’s a participating whole life policy, it may also offer dividends if the company performs well.
• Fixed/Traditional Universal life insurance: This policy offers flexible premiums that can be adjusted. The cash value earns interest at a declared rate set by the insurance company.
• Indexed Universal Life (IUL): Cash value growth is tied, in part, to a market index, typically with floors and caps.
• Variable Universal Life Insurance: In this policy type, cash value is invested directly in market subaccounts that come with investment risks, including the potential for loss of principal.

The cash value on all these policies is accessible and offers liquidity. Thus, these policy types count as an asset.

How Cash Value Builds Over Time

Cash value within your permanent life insurance policy can be accessed while you’re living  as a present-day financial resource. Here’s how cash value builds:

• When you pay premiums, a part of it is used for maintaining the cost of coverage, while the rest goes for the cash value growth. 
• As you keep paying the premiums, your cash value can grow over the years through guaranteed interest, market-linked crediting or investment-like subaccounts, depending on the policy type. 
• The cash value growth is tax-deferred, meaning you don’t pay taxes on the accumulating funds. 
• It works somewhat like a savings account from which you can withdraw funds or borrow from if needed. Policy loans are also charged interest.

Accessing the cash value can reduce the death benefit for your beneficiaries or even cause the policy to lapse, if you take out too much and it’s not repaid.

Read: What is Life Insurance Trust?

How to Access the Cash Value

Once substantial cash value has accumulated in your policy, you can access it in multiple ways, including withdrawing funds or taking out a loan. If you access your cash value, you should ensure there are enough funds in the policy to keep the coverage active. You may also surrender your policy to get the cash surrender value, but in that case coverage would end.

• Withdraw from the Cash Value: On accumulating enough cash value on the policy, you can withdraw a part of it to repay loans, fund education expenses or supplement retirement income. But remember, withdrawing funds can also reduce the death benefit for the beneficiaries and may sometimes trigger taxes.
• Take Out A Policy Loan: Rather than withdrawing the cash value outright, you can borrow from it. Unlike traditional loans, you often get these loans without a detailed credit check. However, policy loans do include interest. If at any point your outstanding loan balance goes over the policy’s cash value, your policy may lapse. Plus, unpaid balance and due interest can also reduce the overall death benefit for the beneficiaries.
• Surrender the Policy: You can surrender the policy, which means to cancel the policy before maturity and take the cash surrender value (cash value minus surrender charges). This option may offer you an instant payout, but your coverage may immediately end, so it is suitable only if you no longer need the protection. If the cash surrender value you receive is higher than the total premium you’ve paid, you may have to pay taxes. 

Tax Treatment of Cash Value Growth

Typically, the cash value on your life insurance policy grows tax-deferred, meaning you don't pay any taxes on the accumulated value. But taxes may apply in the following cases:

• If you use the cash value to withdraw funds, and the withdrawal amount is higher than the total premiums you’ve paid over the years, then the excess amount is taxable (not the whole withdrawal amount).
• If you surrender the policy and the cash surrender value that you receive is higher than the total premiums paid, the excess amount is taxable (not the whole cash surrender value).
• Policy loans are often not taxable, but if your policy lapses, the outstanding amount can be treated as income. Here, taxes can imply any value above the total premiums you’ve paid.

If the withdrawal amount or cash surrender value is lower than the total premiums you’ve paid, you typically won’t have a tax liability.

How to Use Life Insurance to Build Wealth

Your life insurance policy’s cash value can be a strategic asset that you may use to strengthen your overall financial plans.  Here are some ways in which cash value can help you build a diverse assets profile:

• Funds in the cash value can be used for down payments often needed for the purchase of real estate.
• You can also consolidate your ongoing debts with cash value and reduce your liabilities.
• Market-linked cash value growth can offer growth potential depending on policy features and market conditions.
• Accumulated cash value can act as an emergency fund while you use your income and other liquid funds for fulfilling major expenses or purchasing other assets. 

Life insurance can be a smart wealth-transfer tool, as it pays a death benefit to your beneficiaries that is generally tax-free. This allows you to transfer wealth without liquidating other assets. To accelerate the growth of your cash value and build long-term wealth, you may consider overfunding.

Overfunding means paying more than the minimum required premium so more of your payment goes toward the policy’s cash value. Doing this can help you build accessible cash value more quickly, which may increase your ability to borrow or use the funds for future financial needs. Just keep in mind that exceeding IRS limits can cause the policy to become a Modified Endowment Contract (MEC), which changes how loans and withdrawals are taxed.

Read: How Long is Term Life Insurance

Life Insurance and Estate Planning

When you consider your policy as an asset, it makes sense not only during your lifetime but sometimes also after you pass away. Beyond offering protection and acting as a financial asset, your permanent policy can become a part of your estate plan.

When Cash Value Counts Towards Net Worth

The cash value on your life insurance policy is accessible as an asset, as it allows withdrawals and loans during the lifetime. Thus, it can add to your total net worth. That’s why it may be treated as marital property during divorce settlements, especially when it is a joint life policy or you need to provide alimony or financial support.

When the Death Benefit Can Trigger Estate Tax

Usually, only the policy’s cash value is treated as an asset, not the death benefit. But the death benefit may add to your taxable estate after your death. This usually happens when you’ve not transferred the policy’s ownership during your lifetime or when the estate is the beneficiary. In such cases the death benefit payout is added to the total estate value. If this value goes over the federal estate-tax limit, the excess value is taxable.

You might consider structuring ownership and beneficiaries in a way that supports your current needs and future goals for your family without unnecessarily increasing your taxable estate

Pros and Cons of Treating Life Insurance as an Asset

When people prefer considering their life insurance as an asset for the liquidity and convenience it offers. But it’s not always a go-to option, as using it as a living benefit may reduce benefits for your beneficiaries. It’s good to weigh the trade-offs with the potential benefits before making a choice.

Pros:

• You can withdraw funds from the cash value while keeping the policy active.
• Policy loans often require no paperwork or credit check.
• Offers long-term protection with cash value liquidity.
• Funds in the cash value can be used to supplement retirement income.

Cons:

• Withdrawing funds can reduce the death benefit for the beneficiaries
• Cash value may take several years to build
• Asset building is only possible with permanent policies, which are generally more expensive than term policies.
• Surrendering a life insurance policy immediately ends the coverage; surrender charges may apply.

When Life Insurance Should NOT Be Treated as an Asset

Counting your life insurance policy as an asset may be smart for your long-term financial planning, but not always. You should not consider your life insurance as an asset when:

• You own a term life policy, as it doesn’t include a cash value.
• Your policy has just started, and there’s not enough cash value.
• You need a higher loan amount than the policy’s cash value. 
• Your policy is underfunded and may lapse.