Life insurance: you need it or you don’t. It’s that simple, right? Well, not exactly. There are countless uses for life insurance that I’ve seen over the years, and a few times when it really wasn’t needed. Today, we’ll talk about the uses of life insurance and what to do when you have a policy you no longer need.
- Traditional Death Benefit - This is one of the most popular uses. Depending on the face value of your policy, life insurance will provide your beneficiary(s) with a lump sum payment in the event of your death.
- Collateralize a Loan - Life insurance can be used to pay off a lender in the event of your death. Many lenders require life insurance.
- College Planning - Cash value life insurance (and annuities) are the only non-qualified assets that are not assessed for financial aid purposes. A policy can also be used to pay off college for your children in the event of your untimely death.
- Fund a Business Buyout/Succession Plan - Business partners can buy insurance on each other and sign an agreement guaranteeing that they will buy the business from your family in the event of your death. A premium payment for life insurance can be a lot cheaper than writing a check for a large sum, especially when cash flow is at a premium following the death of a partner.
- Creating a Legacy - You can work your entire life to save money to leave to your family or you can buy a policy and accomplish the same thing.
- Create a Charitable Legacy - It can be less expensive to leave the local hospital a life insurance policy (especially one you no longer need) than it is to write a check or reduce your heirs’ inheritance.
- Balance an Inheritance - If you own a business that some, not all, of your children work in, it may not be fair to leave it to all of them. Instead, the children working in the business inherit it, and the others get the equivalent from life insurance.
- Pay Taxes - Now that the estate tax exemption has been raised, most households won’t have a Federal Estate tax (for now) but may have a state or local tax. Why pay $1 for $1 of tax when you can transfer that future cost to an insurance company for a fraction of the cost by leveraging your dollars using life insurance instead?
- Cash Flow - In some instances, the cash value portion of a life insurance policy may be accessed tax-free. Imagine a source of readily available capital. You can take a loan from the policy or surrender up to your cost basis for a tax-free withdrawal.
- Alternative to Money Markets or CDs - A 5% potential cash value credit may be more than the interest you might receive from a CD or money market if the Federal Reserve cuts interest rates. Life insurance is its own asset class.
- Hybrid Long-Term Care - Life insurance may be easier to qualify for than traditional long-term care insurance. Many people resist buying long-term care insurance because they don’t want to pay for something they think they might never use. In reality, there’s a 70% chance you will need long-term care after age 65 (longtermcare.gov). With a hybrid policy, even if you don’t end up using the long-term care portion, your beneficiary(s) still receive a death benefit when you die.
If you have an old life insurance policy that you no longer need for any of the above reasons, you can potentially:
- Surrender it for the cash value
- Convert to reduced paid-up
- Convert to extended term
- Sell the policy
As you can see, life insurance can be a very versatile tool!
Frequently Asked Questions About Life Insurance
1. What are some common uses for life insurance beyond providing a death benefit?
Life insurance can serve several purposes beyond traditional income replacement. Depending on the policy and your circumstances, it may be used for business succession, college planning, creating a family or charitable legacy, balancing inheritances, providing liquidity for taxes, or accessing cash value.
2. What can I do with a life insurance policy I no longer need?
If your circumstances have changed and you no longer need an existing policy, you may have several options, including surrendering it for its cash value, converting it to reduced paid-up insurance, converting it to extended-term insurance, or potentially selling the policy.
3. Can life insurance help with long-term care expenses?
Certain hybrid life insurance policies combine a death benefit with long-term care benefits. This can provide flexibility: if long-term care is needed, the policy may help cover those costs, while if the benefit isn't used, beneficiaries can still receive a death benefit.