How To Use Life Insurance To Build Wealth


Life insurance is a valuable tool designed to protect loved ones from devastating financial losses due to the death of an insured policyholder. Although this is an important component of life insurance, certain types of life insurance policies come with added benefits. If used properly, a life insurance policy not only gives financial support to beneficiaries after the policyholder dies but can also accrue cash and build wealth in the process.

Life insurance is generally considered a means to financially aid grieving family members after the blow of losing a loved one in death. However, this aspect of life insurance policies is just one feature of the various life insurance products available. Although somewhat lesser known, many policyholders use life insurance plans with a cash value component. This type of life insurance policy provides both the death benefit and also wealth-building potential during the policyholder’s lifetime.

Does a life insurance policy with a cash value component really make for a good long-term investment?

“Depending on the type of life insurance policy you choose,” says Brad Cummins, CEO at Insurance Geek, “you could rack up many benefits and tax-related advantages. These can include generating a market-linked return on the policy’s cash value, but without any downside market risk.”

In this article, we will examine what types of life insurance are out there, what types of life insurance create cash value growth, and whether these are good long-term investments to build wealth.

What is a life insurance policy?

In most cases, a life insurance policy is just “insurance” — a death compensation guarantee in return for paying a premium. Granted, this is similar to what many people think of in terms of an investment — expending money with the expectation of achieving a profit. The big difference between investment and insurance is that insurance comes with a guaranteed return or “compensation” (dependent upon certain criteria being met.)

For some life insurance products, the return or “compensation” comes solely as a payout to your beneficiaries. With other types of life insurance products, there is a cash value associated with the policy, which can increase over time. As you pay the premium, that money is put aside into a cash account.

There are two main categories of life insurance: term life and permanent life. Let’s take a look at these different types of life insurance policies to better understand their benefits and limitations.

Life insurance policies are not just for aged adults. Take a look at our article Baby Life Insurance: Do Newborns Need a Policy? to see why people are buying life insurance for minors.

Term life insurance

Term life insurance is generally a cheaper type of insurance that provides coverage for a set period of years. Depending on the type of coverage, if monthly premiums have been paid and the term has not finished, a payment would be made to a named beneficiary at the time of the policyholder’s death.

The term can be offered for anywhere from five to 50 years. Some term life policies expire at the end of the term, whereas others can be renewed for an additional length of time. Some policies come with fixed premiums, whereas others are sold with variable premiums that go up over time.

Here are a couple of unique types of term life policies:

  • Decreasing term life. This type of policy comes with a death benefit that gets smaller over time. Many people buy this type of policy if they expect their loved ones to gradually need less financial support later in life.
  • Convertible term life. This type of policy comes with the option to allow the policyholder to convert some or all of their term life coverage into permanent life coverage. Some companies do not offer convertible term life policies, but rather offer what is sometimes called a conversion rider (or conversion endorsement).

Benefits of term life

The benefits of a term life policy are highlighted in the following example. Let’s say Joe is 40 years old and buys a 30-year term life insurance policy with a death benefit of $1 million. He pays premiums at $125 each month until he’s 67, and then unexpectedly dies of a heart attack. Joe has paid monthly premiums totaling $40,500, but has made it possible for his beneficiaries to receive a lump-sum payment of $1,000,000.

Want to buy a term life policy? Take a look at the best term life insurance policies.

Limitations of term life

In terms of wealth accumulation, term life insurance is not the best option. Paying premiums does not accrue savings or interest because there is no cash value account. Usually, the only way for a policyholder to make money from a term life policy is to sell the policy to a life settlement company. In addition, there is the possibility that the policy term may end before the policyholder dies, which would mean zero payouts.

Remember this

Important: Life settlement companies advertise to buy out insurance plans from policyholders to access the death benefit in advance. After “purchasing” the policy, they begin paying premiums and give you a lump sum of money based on your age, health, and the size of the death benefit. Although this can generate cash, selling a life insurance policy is a poor investment because it deprives your beneficiaries of the death benefit.

Permanent life insurance

Different from term life insurance, permanent life insurance policies remain in effect for the lifetime of the policyholder, provided that the premiums are paid. Permanent life insurance products are more than just life insurance. These policies have a cash value that can accumulate over time as premiums are paid.

Remember this

Important: For most permanent life insurance polices, after the policyholder dies, the cash value portion goes back to the insurance company. The beneficiaries will receive the death benefit, but not any cash value accrued. Before buying a policy, make sure to check if the specific policy will pay out the cash value to beneficiaries or not.

There are a variety of different types of permanent life insurance policies on the market with a cash value component. The most common are whole life, universal life, indexed life, variable life, and final expense life insurance.

  • Whole life insurance. This is the simplest kind of permanent life insurance. There is a fixed interest rate for the cash account and premiums stay the same for the life of the policy. According to some estimates, the average whole life fixed interest rate is 1.5%. (source) This is quite low in comparison to many investment products.
  • Universal life insurance (ULI). Also known as adjustable life insurance, UIL is a flexible version of permanent life insurance. UIL often allows the death benefit to be increased or decreased and even allows you to adjust or skip your monthly premiums (with limitations). Opposed to whole life, the interest rate for the cash account is not fixed but will not drop below a certain threshold or dip into the negatives. ULI interest rates increase based on market conditions.
  • Indexed universal life (IUL). This is a type of universal life insurance where the interest rate is determined by a stock market index chosen by the insurance company. The money in the cash account is not directly invested in the selected index, but rather, the interest rate goes up and down reflecting the index’s performance. Most policies offer an interest rate guarantee, which limits losses when an equity index drops.
  • Variable life insurance. This is a risky type of permanent life insurance. Variable life insurance interest rates fluctuate based on investment options you choose, rather than a stock index that the insurance company chooses. If the investment options you choose for the policy perform poorly, you can lose money from your cash value account.
  • Final expense life insurance (aka burial insurance). This is the most affordable type of permanent life insurance policy. The death benefit is smaller (usually a max of about $35,000) and designed to help your loved ones pay for funeral costs, medical bills, or outstanding loans. Final expense insurance is not designed to build wealth — it is primarily for those in poor health, and for people age 50 and older.
Permanent Life ProsPermanent Life Cons
Tax-free accumulation of the cash valueHigher premiums than term life insurance
Tax-free retirement incomePossible slower growth compared to equities
Tax-free death benefit for the beneficiaryThere is a surrender charge in the early years
Penalty-free access for long-term care needsContributions are not tax deductible

Term life insurance compared to permanent life insurance

As was discussed earlier in this article, term life can be cheaper than permanent life insurance, has no cash value account, and is only active for a set number of years. If used properly, the cash account associated with a permanent life policy can give better returns than some types of investments. On the other hand, you could lose out on better investment opportunities if not used properly. Let’s take a deeper look at how to use life insurance to build wealth.

How to convert a term life insurance

If you have a term life insurance policy and would like to begin accruing cash value, ask your insurance company what would be involved to convert to a permanent life policy. Although the monthly premiums will be more expensive if your current plan qualifies to be converted, you will likely save money in the long run. When the cash value component increases beyond a certain threshold, it will not only pay monthly premiums but can even payout thousands of dollars each month.

Brad Cummins, quoted earlier, says, “One downside of life insurance retirement plans is that because it’s a life insurance contract, you have to qualify for this type of retirement strategy medically. Because this is life insurance coverage, there is underwriting from the insurance company. If you have any major health issues or terminal illnesses, a LIRP strategy will not work for you.

Life Insurance TypeCoverage LengthBest for AgesBuilds Cash Value?Growth Potential
Term5 – 50 years-65No
Final ExpenseLifetime50 – 85No

Check out our article Life Insurance for Seniors: 8 Reasons You Need It & How to Get the Right Policy. If you’re over 65, you’ll find tips to get the right policy that fits your needs.

How to build wealth with permanent life insurance

There are a variety of ways to use permanent life insurance to build wealth and provide tax-free income after retirement. The right option for you will depend on your current income-to-expense ratio, tax situation, future income needs, needed death benefits for beneficiaries, and the value of your estate.

IRAs, annuities, and life insurance

For many taxpayers, a 401(k), IRA, or annuity can offer more tax benefits than a life insurance plan by taking advantage of the IRS Saver’s Credit. Using life insurance as merely an investment product is a BAD IDEA. You may pay more money in fees than the interest you earn (the truth about fees). On the other hand, if you expect to regularly exceed annual retirement contribution limits, you can use life insurance to provide additional tax-free income later in life (IRA, Roth IRA and 401(k) IRS contribution limits).

Cummins explains, “if you’ve already ‘maxed out’ your IRA and other retirement plan contributions, you may be seeking additional tax-advantaged vehicles. That’s where life insurance comes in. By adding permanent life insurance, you can diversify your portfolio from tax consequences. Life insurance can also provide you with flexibility and preferential tax treatment, both now and in the future.”

Tax-Free income from IUL cash value accumulation example

Let’s look at an example of how an IUL insurance policy can be used to build wealth. Cummins states, “Jim, who’s 40, is looking to save additional money for retirement. He purchases an Indexed Universal Life policy and pays $24,000 for 15 years while he’s still working. The cash value grows tax-deferred for 26 years. If Jim retires at age 67 and chooses to start taking income a year later, he can potentially withdraw $135,114 a year for 23 years on a tax-free basis from the policy’s cash value. And he still has a death benefit in place to protect his family, should he die prematurely.”

AgeYearLife insurance premiumLife insurance cash surrenderLife insurance tax-preferred incomeIncome tax-free death benefit
Total premiums paidTotal tax-preferred income

Bottom line

Life insurance provides protection for your loved ones after your death but if used properly, can also build wealth as a retirement vehicle. Using life insurance to provide retirement income is not for everyone. If you regularly exceed retirement account contribution limits, using permanent life insurance to create additional income later in life may be the right option for you.

Are you wondering which life insurance product is right for you? Check our article I Need Life Insurance. What Kind of Life Insurance Should I Buy?

Frequently asked questions about life insurance as an investment

What is a life insurance annuity?

A life insurance annuity is different from a life annuity. Life insurance annuities allow the death benefit to accrue interest in an annuity account until fully paid out. This allows for a steady stream of income to the beneficiary.

How long does it take for permanent life insurance to build cash value?

Depending on the type of permanent life insurance policy, it generally will take between two to five years to begin accruing cash value. However, it can take decades to see significant cash value accumulation. An account can accrue cash value faster if additional premiums are paid, but if too much is paid at once in the early years of the account, the IRS will permanently label the policy as a MEC (Modified Endowment Contract).

What is an MEC?

A MEC is what the IRS labels an insurance policy when it becomes overfunded. The interest earned in the cash value portion of permanent life insurance is subject to taxation. Normally, the interest earned on the cash value account is the last to be withdrawn. When a life insurance policy is labeled a MEC, the interest earned is the first to be withdrawn and is subject to taxation. To avoid a whole life policy being labeled as a MEC, it must stand the 7-pay test.

What is the cash value component of a life insurance policy?

The cash value component of a life insurance policy is essentially a savings component included in permanent life insurance policies. As you pay premiums, a portion of the payment is added to the cash value of the account.

The cash value can grow at a fixed interest rate or a variable rate, depending on the insurance policy. You can borrow against the cash value account in the form of a life insurance loan. With universal life insurance plans, the cash value can be used to reduce the premium or increase the death benefit.

Key Takeaways

  • Life insurance is a legally binding contract that provides a death benefit to the policy owner upon the insured’s death, subject to premium payments.
  • Term life insurance policies have a specific duration, while permanent life insurance policies remain active until the insured’s death, cessation of premium payments, or policy surrender.
  • Permanent life insurance policies accumulate a cash value that can grow through interest and contribute to building wealth.
  • Utilizing a whole life insurance policy can be beneficial for individuals who consistently surpass retirement contribution limits.
View Article Sources
  1. Types of Cash Value Life Insurance – Washington State Office of the Insurance Commissioner
  2. Is Whole Life Insurance Right for You? – Consumer Reports
  3. Types of Policies – New York State Department of Financial Services
  4. Can I Sell My Life Insurance Policy? – Texas Department of Insurance
  5. Estate Tax – Internal Revenue Service
  6. Life Insurance & Disability Insurance Proceeds – Internal Revenue Service
  7. Retirement Topics – IRA Contribution Limits – Internal Revenue Service
  8. Retirement Topics – 401(k) and Profit-Sharing Plan Contribution Limits – Internal Revenue Service
  9. Variable Life Insurance – U.S. Securities and Exchange Commission
  10. Retirement Savings Contributions Savers Credit – Internal Revenue Service
  11. Amount of Roth IRA Contributions That You Can Make for 2023 – Internal Revenue Service
  12. Retirement Topics – IRA Contribution Limits – Internal Revenue Service
  13. 401(k) Limit Increases to $22,500 for 2023; IRA Limit Rises to $6,500 – Internal Revenue Service
  14. Retirement Plan Limitations for 2023 – Internal Revenue Service