What Can You Use Life Insurance For?

Life insurance is a financial instrument offering more than a death benefit. It supports financial planning by addressing various needs throughout an individual’s life. Life insurance can create financial stability, accumulate accessible wealth, support long-term legacy objectives, and ensure business operations. Understanding its uses allows individuals and entities to manage financial risks and achieve monetary goals.

Providing Financial Security

The primary function of life insurance is to deliver financial security to beneficiaries upon the policyholder’s passing. This is achieved through the death benefit, a tax-free lump sum payment to designated recipients. This financial influx helps mitigate the economic impacts that can arise from the loss of an income earner.

Income replacement for surviving family members is a primary use. The death benefit can provide funds, allowing dependents to maintain their standard of living. This is relevant for families relying on the insured’s income for daily expenses and housing costs.

Life insurance proceeds can also repay outstanding debts. Mortgages, personal loans, vehicle loans, and credit card balances often burden surviving family members. A life insurance payout can extinguish these liabilities, preventing foreclosure or interest accumulation, protecting family assets.

Funding for children’s education is another use for the death benefit. The funds can cover tuition fees, living expenses, and other educational costs, ensuring that educational aspirations are not derailed by the policyholder’s absence.

The death benefit can cover funeral and final expenses. These costs include burial or cremation services, memorial arrangements, and any outstanding medical bills. Covering these expenses alleviates financial strain during grief.

Leveraging Policy Cash Value

Certain types of life insurance, permanent policies like whole life and universal life, include a cash value component that accumulates over time. This cash value grows on a tax-deferred basis and can be accessed by the policyholder during their lifetime.

Policyholders can borrow against their accumulated cash value, without undergoing credit checks. Interest rates for such loans are competitive.

An outstanding loan balance and accrued interest will reduce the death benefit paid to beneficiaries if not repaid. If the loan balance grows to exceed the cash value, the policy could lapse, potentially creating a taxable event.

The cash value can serve as an emergency fund for unforeseen expenses. It can also supplement retirement income, offering a tax-advantaged stream of funds. Policyholders may access the cash value through withdrawals or by surrendering the policy, though withdrawals can reduce the death benefit and surrendering ends coverage.

The cash value can act as collateral for external loans. It can also be used to fund significant life events or purchases, such as a down payment on a home, a business investment, or educational costs.

Supporting Estate and Legacy Goals

Life insurance plays a role in estate planning and wealth transfer. The proceeds are generally income tax-free to beneficiaries, making it an effective tool for wealth distribution.

The policy can provide liquidity for estate expenses, such as federal estate taxes or administrative costs. Life insurance can prevent the forced sale of illiquid assets, like real estate or a family business, to cover tax liabilities.

Placing a life insurance policy within an Irrevocable Life Insurance Trust (ILIT) can remove the policy proceeds from the taxable estate. This strategy ensures the death benefit is not subject to estate taxes. The ILIT owns the policy, and the death benefit is paid directly to the trust, bypassing probate.

Life insurance facilitates charitable giving by allowing policyholders to name charitable organizations as beneficiaries. This enables a donation without impacting current finances. Transferring policy ownership directly to a charity removes it from the taxable estate, reducing potential estate tax burdens.

Life insurance can be used to equalize inheritances among heirs, particularly when an estate includes non-liquid assets like a family business. For instance, a business owner might leave the company to one child active in its operation, while providing an equivalent tax-free cash distribution from a life insurance policy to other children.

Business Continuity and Benefits

Life insurance supports business continuity and employee benefits. These applications focus on protecting the enterprise from financial disruption and attracting or retaining talent.

Key person insurance safeguards a business against the financial impact of losing an employee. This policy, owned by the business with the business as beneficiary, provides funds to cover losses from the absence of an individual whose skills or leadership are important. Proceeds can be used for recruiting and training a replacement, replacing lost revenue, or settling debts.

Life insurance is a funding mechanism for buy-sell agreements among business partners or shareholders. These agreements dictate the orderly transfer of ownership upon a partner’s death, disability, or retirement. The life insurance provides liquidity to purchase the deceased owner’s interest from their estate.

There are two structures for funding buy-sell agreements with life insurance: entity purchase (where the business buys policies on each owner) and cross-purchase (where each owner buys policies on the others).

Life insurance is utilized in executive benefit plans to attract and retain talent. Non-qualified deferred compensation (NQDC) plans can use cash value life insurance as an informal funding vehicle, allowing executives to defer income until retirement. The policy’s cash value can grow tax-deferred, and the death benefit can provide pre-retirement protection.

Executive bonus plans involve the company paying premiums on a life insurance policy owned by a key employee. The premiums are treated as a bonus, deductible by the company, and the employee gains ownership of a policy that builds cash value and provides a death benefit.