Life Insurance For Generational Wealth 

All life insurance policies have one thing in common: they pay a death benefit to the life insurance policy beneficiaries upon the insured’s death.

However, some insurance plans do more. They also help you build generational wealth by passing tax-advantaged assets to your heirs. Let's cover this in more detail.

What is Life Insurance and How Does it Work?

Life insurance is a contract between an insurance company and the policyholder, where the insurance company promises to pay a death benefit to the policyholder’s designated beneficiaries if the policyholder dies within a certain time frame.

In exchange, the policyholder pays premiums to the insurance company. It can provide a financial safety net for the policyholder’s loved ones, helping to cover essential expenses, pay off debts, and maintain their standard of living.

There are two main types of insurance: term life insurance and permanent life insurance. Term life insurance covers a specific period, such as 10, 20, or 30 years, and pays a death benefit if the policyholder dies during that term.

On the other hand, permanent life insurance covers the policyholder for their entire life, as long as premiums are paid, accumulating a cash value over time. This cash value can be accessed during the policyholder’s lifetime for various financial needs, making permanent life insurance a versatile tool for long-term financial planning. Often, beneficiaries will use a life insurance payout to pay off a mortgage, fund college educations and pay bills until jobs or careers can be established.

Understanding Life Insurance Policies

It gives you peace of mind that your dependents, such as a spouse or children, will be financially looked after during your death. The proceeds from your policy can help them cover various expenses, including, but not limited to: 

• Household bills
• Mortgage installments
• Childcare costs
• Funeral costs
• Children’s education costs

There are two main types of insurance: term life and permanent life. 

Term Life Insurance

Term life insurance runs for a predetermined period, such as 10, 20, or 30 years. Your beneficiary receives a tax-free lump sum if your death occurs during the policy term. If you outlive the policy, no payment is issued. 

While term life insurance is a great fit as an income replacement tool, it is no good if the aim is to generate wealth for future generations. This is because there’s no guarantee that your family will receive a death benefit. 

Permanent Life Insurance 

It doesn’t come with an expiration date. It pays out no matter when you die as long as you pay the premiums. It offers a strategic means to pass on tax-advantaged assets to heirs and augments wealth accumulation. Thus, it is an excellent choice for generating wealth.

Along with lifetime coverage, permanent life plans build cash value. You can access it anytime and for any purpose during your lifetime. Most people use their policy’s cash value to fund a big purchase, meet a financial emergency, or grow their retirement nest egg. If you do ultimately get a permanent life insurance policy, typically people have two options for using it to generate wealth: Take out cash.

How is life insurance connected to generational wealth?

Permanent life insurance and generational wealth planning go hand in hand. You may consider using it as a wealth transfer tool for three primary benefits: lifetime coverage with cash value growth, guarantees, and simplicity.  

Benefit 1 – Permanent life insurance coverage

It provides coverage for as long as you live and accumulates cash value. The policy's cash value can be accessed during the policyholder’s lifetime for various financial needs, ensuring a stable amount for beneficiaries. Giving assurance your loved ones will eventually receive a payout can offer you greater flexibility to spend funds in retirement.

Example: Liam and Sophia have roughly $2.5 million in their retirement fund. They have saved enough to enjoy their golden years but are worried about leaving significant money to support their grandchildren’s college education, which could cost about $1 million.

By including insurance in their financial planning strategy, they can ensure their grandchildren will have enough money to pursue higher education after they’re gone, regardless of when that happens. This may even give them more freedom to use their retirement funds as they please and fully enjoy their golden years.

Benefit 2 – Guarantees

Whole life insurance offers policyholders many guarantees. For instance, the premium rate and death benefit remain the same while the cash value grows fixedly. In addition, you can fund a policy with a single, large payment — which can make a lot of sense if you want a “fill it, forget it” insurance solution. 

Example: After much research, William and Sophie decided that a $600,000 insurance plan is their best option for setting money aside for their grandchildren’s education. They want a solution that can be paid in total upfront, provides permanent coverage, and has a death benefit set in stone. Its policy from a reputable provider may be the perfect fit for them. 

Apart from giving guaranteed returns on the premiums, some whole life plans — called participating whole life insurance — also pay annual dividends. Although dividend payments are not guaranteed, many top insurers have a track record of paying them almost yearly. If William and Sophie buy a participating whole-life policy, they can use the dividends to raise their policy’s guaranteed growth. 

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Benefit 3 – Simplicity

An insurance has all the makings of a smart estate planning tool. Its proceeds are not taxable to the beneficiary, can bypass probate, and are protected from creditors.

Tax benefits

A life insurance payout is not taxable if someone other than your estate is the beneficiary. No income tax dollars are owed on money received from an insurance policy benefit.

Bypass probate

The proceeds of your policy can bypass probate — a legal and sometimes costly procedure your estate goes through before your assets can be distributed. They are paid directly to your beneficiaries without the need for court intervention. 

Asset protection

Unless you’ve named the estate your beneficiary, creditors can’t go after the proceeds of your policy. The death benefit is protected from the policy owner’s and the beneficiary’s creditors. 

Example: Leo and Charlotte have selected a $1 million whole life insurance plan. The premiums fit nicely in their budget, and they like that this money will be paid tax-free to their three children and protected from potential credit claims against their estate. 

Choosing the Right Life Insurance Policy

Permanent life insurance is a viable option for building wealth. Whole life insurance, universal life insurance, and variable life insurance are three of the most common types of permanent life insurance. Which of them is right depends on your financial goals, budget, and risk tolerance. 

Whole life insurance 

It combines lifetime coverage with a savings component. Part of your premium payments builds cash value, which you can access by withdrawing or taking out a policy loan. Your premium rate and death benefit won’t change, and the cash value will grow fixedly. 

Universal life insurance

Universal Life doesn’t offer fixed cash value growth but lets you adjust your premium payments and death benefits within limits as your life circumstances change. You can also use the cash value to pay premiums, something that whole life doesn’t allow. 

Compared to whole life, universal life insurance is more affordable. 

Variable life insurance

Like whole and universal life, variable life insurance covers you for life and builds cash value. You can invest the cash value in various investment options, including stocks, bonds, and mutual funds, which could lead to more significant growth.  

However, with the potential for higher returns comes greater risk. If the underlying sub-accounts perform poorly, you can lose much or even all of the cash value. Given the inherent risk associated with the cash value component of variable life insurance, it is not the best option for building generational wealth.

Factors to consider when choosing a policy for building generational wealth

The type of policy and amount of coverage you need for building generational wealth depends upon your financial goals, risk tolerance, and budget. The three most important things to keep in mind are: 

Adequate protection

Regardless of the type of policy you choose, make sure the sum assured is enough to meet your family's financial needs upon death. 

Premium costs

Premiums differ from different types of insurance. For example, whole life insurance is pricier than universal and variable life insurance. Since most permanent life plans require premiums to be paid throughout the insured’s lifetime, pick a policy whose premiums you’ll be able to pay over a long period. If you default on premium payments, you risk losing the coverage.

Beneficiary Designations

It’s important to consider how you want the policy proceeds to be distributed between your dependents. You should also review the beneficiary designations whenever a significant life event occurs, such as marriage, divorce, or death of a named beneficiary.  

Conclusion 

Permanent life insurance is a good option for building generational wealth and has different types, so you must pick the right plan for your unique situation. If you’re unsure which type of policy is the best fit for you or how much coverage you need, let Dundas Life help you. Schedule a call to have one of our advisors walk you through your options and pick a product that aligns with your long-term goals. 

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Frequently Asked Questions (FAQs)

Can insurance payouts be taxed?

Insurance proceeds are usually not taxable, but a few exceptions exist. If the policy beneficiary opts to receive the death benefit in installments, they may owe tax on insurance. Fortunately, they must pay tax only on the earned interest amount — not the entire death benefit. The other situation in which a death benefit is counted as taxable income is when the deceased’s estate is the beneficiary. 

Can the cash value of a life insurance policy be used during the policyholder’s lifetime?

Yes, you can (and must) use your policy’s cash value during your lifetime. Usually, the beneficiary receives only the death benefit, not unused cash value at your death. You can use the cash value to help achieve financial goals such as: 

• Pay for a child’s college tuition
• Pay for a home down payment
• Pay for any other big purchase, such as a car or a house remodel
• Supplement your retirement income
• Create an emergency fund
• Start a business

How can you access your policy’s cash value? 

You can access the cash value through withdrawals or policy loans. The cash value component of your policy is like a savings account in the sense that you can withdraw money from it at any time. But keep in mind each withdrawal will reduce the death benefit. A policy loan might be a better option if you don't want that. While the insurer will charge you interest on the loaned amount, the interest rate is much lower than the average for personal loans and credit cards.

Is it possible to change the beneficiary of a life insurance policy?

You can change the policy beneficiary any time by contacting your insurer and submitting a change of beneficiary form. However, if your policy has an irrevocable beneficiary, you need their consent to update the beneficiary designation. 

How can insurance protect against market volatility?

Whole life insurance accumulates cash value on a fixed rate, no matter what markets do. For this reason, it is a good choice for those looking to diversify their portfolio and reduce market risk.