One result of accumulating wealth may be a desire to keep it in the family by passing along assets to future generations. Life insurance is a popular way for the wealthy to maximize their after-tax estate and have more money to pass on to heirs.

A life insurance policy can be used as an investment tool or simply provide added financial reassurance. While life insurance isn’t something that wealthy people alone can benefit from, there are several unique reasons that someone with a higher net worth may consider purchasing it.

Key Takeaways

  • Life insurance can be a useful financial tool for business owners or individuals with a higher net worth, as well as for people who may not have accumulated as many assets.
  • It’s possible to purchase more than one life insurance policy to meet different financial needs, though this can mean submitting to multiple paramedical exams during underwriting.
  • Life insurance policies are not counted as part of an estate and are not taxed by the federal government, which may appeal to individuals who are hoping to minimize estate taxes.
  • A life insurance policy can be sold for its cash value, or you can borrow against its accumulated cash value during your lifetime.

Tax Laws Favor Life Insurance

One reason why the wealthier may consider purchasing life insurance has to do with taxation. Tax law grants tax benefits to life insurance premiums and proceeds, affording asset protection in the process. The proceeds of life insurance are also tax-free to the beneficiary. This could be appealing to an individual with a higher net worth or to anyone who seeks to minimize estate taxes.

Policy owners with estates of $11.7 million or less can leave this amount to their beneficiaries without having to pay estate taxes, as these are the limits in 2021, as per the Internal Revenue Service (IRS). The proceeds of a large life insurance policy can be used by the policyholder’s heirs to pay a tax bill for individuals whose estates surpass the estate tax exemption threshold. 

Insurance premiums also won’t be subject to estate taxes. For example, if someone spends $500,000 for a $2 million life insurance policy, that initial premium payment comes out of the estate and won’t be taxed.

To look at the insurance premium another way, the after-tax value of the $500,000 is $300,000; thus, for $200,000 ($500,000 premium amount − $300,000 estate tax), the family receives a $2 million guaranteed life insurance payout. That’s a guaranteed return on the premium payment.

Important

A death benefit is a tax-free asset that can be passed on to beneficiaries.

Life Insurance Can Protect Business Owners

If an entrepreneur co-owns a business, then life insurance can fund a buy and sell agreement in the event of an owner’s sudden death. A family business can also benefit from a key person insurance policy. This is insurance on the main person in a small business—usually the owner, founder, or key employees.

A keyman policy protects the firm from going under in the event that key personnel passes away before a replacement is in place. The business itself serves as the beneficiary and is able to use the proceeds for things like hiring and training replacement employees, paying off outstanding business debts, or keeping up with day-to-day operating expenses.

Important

To cover a key person in a business, you need their express written consent as a condition of policy underwriting.

Life Insurance as an Asset

Life insurance is more than a death benefit. Depending upon the type of insurance, it may have a cash value or intrinsic value. Cash value accumulation is a feature of certain types of permanent life insurance, which offers lifetime coverage. Thus, when the insurance is no longer needed, it can be sold as a life settlement.

When properly structured, whole life insurance can offer steady tax-free dividends. This means that your policy can provide an additional stream of income if necessary. The cash value in the policy also builds up and can be borrowed to pay for college expenses or other costs during your lifetime.

Finally, with whole life insurance, your death benefit is guaranteed regardless of your future health. This is important for providing long-term security for the policy owner’s family and heirs. Each of these benefits may appeal to individuals with a high net worth or to anyone seeking to use life insurance as an investment tool.

Important

If you pass away without outstanding loans from a life insurance policy, then the loan amount is deducted from the death benefit that’s paid to your beneficiaries.

Life Insurance Strategies

There are a variety of insurance scenarios to choose from. The right one may depend on things like your current income needs, your tax situation, and other assets that you’re using to fund your financial goals. Here are three example scenarios of how life insurance can be used as part of a broader wealth management plan.

Retirement Plan Funds Life Insurance Strategy

Retirement plan funds—both individual retirement accounts (IRAs) and 401(k)s—can be taxed twice for wealthier individuals: First as income, then with an estate tax. Assume James has $900,000 in his IRA. To avoid losing a large percentage of his IRA to Uncle Sam upon his death, James buys a second-to-die insurance policy with his $900,000. Upon James’ death, his wife receives the $3 million tax-free benefit.

Transfer Current Life Insurance With Cash Surrender Value Policy to Increase Death Benefit

Kevin had a 10-year-old second-to-die insurance policy worth $850,000, with a death benefit of $1.53 million. His advisor recommended that he do a tax-free insurance policy exchange. The new policy had an increased death benefit of $3.48 million, and there were no out-of-pocket charges.

The Two-Step Annuity Tactic

Sarah buys an immediate joint-life annuity for $1 million, which pays $43,843 annually as long as Sarah and her husband are alive. Next, Sarah uses the annual $43,843 payout to fund a $5.68 million second-to-die policy. In essence, Sarah converted $600,000, the after-tax value of the initial $1 million, into $5.68 million. Finally, both the annuity and death benefits are guaranteed.

Is Life Insurance Only for the Wealthy?

While wealthier people may be motivated by potential tax savings or the opportunity to use life insurance as an investment, it’s something that practically everyone can benefit from having. For example, you may need to have life insurance, regardless of net worth, if you:

  • Are married and/or have one or more children
  • Are the primary source of income for your household
  • Have a special-needs dependent
  • Owe co-signed debts, including student loans, a car loan, or a mortgage
  • Want to leave behind money to pay funeral or burial expenses

Those are all reasons to consider purchasing life insurance if you’re interested in creating a measure of financial security for anyone whom you’ll leave behind. The good news is that life insurance may be cheaper and easier to purchase than you might think.

For example, there are a number of companies that offer term life insurance online with affordable premiums, based on age and overall health. While permanent life insurance covers you for life, it can be more expensive. Additionally, permanent life insurance may not be necessary if you’re not interested in accumulating cash value.

Tip

Consider using an online life insurance calculator to determine how much life insurance you need.

The Bottom Line

Life insurance can offer numerous benefits, regardless of net worth or wealth accumulation. When weighing life insurance options, consider what your primary reasons are for purchasing coverage, how much coverage you expect to need, and whether you prefer term life insurance or permanent life. Researching the best life insurance companies and getting quotes for coverage online can help you choose the right policy to meet your needs and financial situation.