3 Ways to Benefit From a Life Insurance Policy While You’re Alive

Quick Answer

Permanent life insurance policies that accumulate cash value can add flexibility to your long-term financial planning. You can use a life insurance policy to fund education, retirement or emergency bills during your lifetime.

Mother watching daughter count coins from piggy bank.

The chief purpose of life insurance is to provide a safety net (or final gift) for your dependents and loved ones after you pass on, but that's not the only benefit a policy can have. There are a number of ways you can also benefit from life insurance during your lifetime, including funding education, retirement planning and accessing emergency cash.

Cash Value Life Insurance As a Financial Resource

There are a variety of forms of life insurance, and many factors to consider when purchasing coverage, but the general proposition is the same for all policies: You make regular premium payments to the insurer and if you die while the policy is in force, the insurance issues a payment to the beneficiaries you designate in the insurance contract.

Certain policies, known as permanent life insurance policies, don't have expiration dates and acquire cash value as premium payments accumulate. It's chiefly these kinds of policies that provide flexibility for the use of the accumulated funds, such as:

  • Borrowing against the cash value: Interest rates on loans taken against a life insurance policy's cash value are often attractive compared with personal loans of comparable amounts. You can pay the loan back anytime, without a fixed repayment schedule. Failure to repay the loan in full will reduce the policy's death benefit, however, and if interest charges cause the amount you owe to exceed the policy's cash value, the policy can be canceled. Be sure to understand all the ramifications if you're considering this option.
  • Withdrawing a portion of the cash value: This results in a corresponding reduction in the death benefit, but withdrawals are not considered taxable income unless they exceed the amount you paid into the policy in the form of premiums.
  • Surrendering the policy: This is essentially canceling your insurance: You notify the insurer that you will no longer be paying premiums, and they issue a check for the policy's surrender value—the policy's cash value, minus fees of up to 40%, as spelled out in your insurance contract. Surrender fees tend to shrink the longer you hold onto (and pay into) a policy.
  • Selling the policy (and the rights to its death benefit) to a third party: This process, called life settlement, typically is limited to older individuals with policies that exceed $100,000 in cash value. It typically yields more than you'd get from surrendering a policy, but money from the sale is taxable. Proceeds you receive up to the amount you paid into the policy is considered income, and any amount over that is treated as capital gains.

Here are some smart ways to take advantage of cash-value life insurance while you're still alive:

1. Tap Your Life Insurance Policy to Fund Your Education

Life insurance can serve as a tax-efficient way to save for education expenses.

Loans or withdrawals from the cash value of a life insurance policy can be a natural complement to savings paid into 529 prepaid tuition plans. Most 529 plans allow proceeds to be used toward tuition at qualifying public colleges and universities, but not for a variety of related college expenses, including room and board.

Furthermore, when you or your child apply for means-based financial aid at a college or university, you are typically required to list financial assets such as securities portfolios, real estate holdings and cash savings. The greater the value of those assets, the less likely you may be to qualify for grants or other assistance. The cash value of life insurance policies is typically not considered an asset for these purposes, so it's a resource that won't work against your aid eligibility.

2. Supplement Retirement Income With Life Insurance

Some investors and retirement planners see cash-value insurance policies as a smart complements to traditional investments in securities, and a good potential source of income in times of stock market downturns: When securities prices are low, tapping an insurance policy that's insulated from market upheaval and has held its cash value may make more sense than selling securities at a loss (or limited gain). Withdrawals from a cash-value insurance policy reduce its death-benefit payout, but they are not considered taxable income unless they exceed the total amount of the premiums you paid into the policy.

3. Enhance Your Financial Security

If you're facing surprise medical expenses or other unexpected bills, tapping the cash value of a life insurance policy can offer a better alternative than raiding retirement savings to cover the costs. A withdrawal from a traditional IRA or 401(k) retirement savings plan made before you turn 59½ comes with a 10% penalty in addition to income tax on the withdrawal. If you withdraw a portion of a life insurance policy's accumulated cash value, you only pay income tax on gains made over and above the premiums you paid in, and there is no penalty regardless of your age.

A more sophisticated approach to using life insurance for medical expenses involves the use of riders—policy additions (that come at a price) that permit living benefits. That is, they enable events other than your death to trigger insurance payouts. Examples include provisions for payouts that cover long-term disability care, assisted living and critical-care needs.

Additional Considerations

Keep the following in mind when considering how you might to incorporate life insurance into financial plans for your lifetime:

  • Permanent life insurance policies are more pricey. Your premiums will typically be higher than term policies that apply for a set period of time and do not accumulate cash value. Both term and permanent policies can play important roles in your plans to provide for your loved ones.
  • It's prudent to think of traditional investments as well. Cash-value insurance policies should be viewed as companion strategies, rather than an all-in proposition. Various types of cash-value life insurance policies earn interest, pay dividends or, in the case of policies known as variable universal life insurance, even let you allocate their cash value among investment vehicles you choose. However, in terms of total investment growth, the amount you pay as insurance premiums over a lifetime might yield a higher return if you placed it directly into a securities portfolio. And of course, traditional stocks and bonds don't pay death benefits.

A financial advisor who's familiar with your needs and goals can help you decide how these options can work best for you.

The Bottom Line

Life insurance is an important element of estate planning, and certain types of life insurance can also be a valuable financial resource for funding education, supplementing retirement income or even covering emergency expenses. A wide array of life insurance policies is available, so consulting an advisor you trust can help you decide the coverage amounts and policy types that best meet your needs.