Life insurance is a valuable estate planning tool that, when properly managed, also allows you to produce income for immediate or long-term use.
Read on to learn how you can earn income on different types of life insurance policies, how this income passes to the beneficiary or the estate, and the different ways it can be used for estate maximization.
Not every life insurance policy has the capability to earn income off of the policy. If you are interested in producing income for your estate, you need to pursue a permanent policy that features a cash value.
A whole life insurance policy provides coverage for the duration of the life of the insured, regardless of how long the policy is held. Premiums are non-fluctuating, and as long as they are current, the insurance company will payout to a beneficiary when the policy is claimed.
Whole life insurance policies feature both a death benefit and a cash value. Part of the premiums are taken by the insurance company and placed into a high-interest bank account or investment account, and interest is earned on a tax-deferred basis.
Whole life insurance policies have a guaranteed rate of return, so you can determine a rough estimate of how much income you will produce with this type of policy.
Universal life insurance, also known as adjustable life insurance, is a more flexible plan. You can increase or decrease your death benefit and pay premiums on a looser schedule.
Payments made to a universal life insurance plan are divided between the death benefit and an investment account, similar to a whole life policy. The difference is that a universal insurance policy always invests a portion of the premium, and you are not guaranteed to earn anything from the policy.
Your investment will rely heavily on market conditions. If the market is going well then there is a better chance of growth, but the opposite is true as well.
Participating life insurance policies earn income from annual dividend payments made from the insurance company to the policyholder. Your premium payments are put into a participating account with other policyholders. These funds are used to pay for costs of the insurance company, such as:
The insurance company may pay you dividends each year, which you can take as cash, use to increase your coverage, or cover your premiums.
This method for using life insurance to produce income can be inconsistent, but companies are likely to pay out dividends most years.
The income produced from a life insurance policy can pass on to the beneficiary on top of the agreed-upon death benefit.
Keep in mind that, while the death benefit of a life insurance policy is non-taxed, any income produced from the policy is subject to tax at the point it is claimed. This applies to any interest or dividends your beneficiary receives alongside the death benefit.
Insurance companies will provide a T5 slip to inform a beneficiary of any tax obligation that accompanies their life insurance payout. The taxes only apply to the amount over the cash value or death benefit, and they do not exceed the earnings.
The only time you should worry about a life insurance policy affecting the estate is when the policy will pass through the estate. This happens when the estate is named as the beneficiary, there is no beneficiary named, or the beneficiary is unable to claim the policy. Otherwise, the policy is paid directly from the company to the individual(s).
If a life insurance policy passes through the estate then the value of the policy, including the death benefit and any interest or dividends paid out, go into the value of the estate. The estate is responsible for income tax based on its value, so the income produced will be diminished by an income tax on that amount.
The income produced from a life insurance policy can be used to increase the value of the policy or to cover the premiums.
This additional financial support is useful when estate planning because it allows the policyholder to focus on other aspects of the estate, including diminishing any debt and setting aside trusts for heirs.
The most direct use of the income from a life insurance policy is allowing it to add to the value of the policy on a tax-deferred basis. While you can tap into the income produced, you risk triggering a tax event before the policy is claimed.
Depending on the size of the policy, how long premiums have been paid into it, and whether the cash value remains intact, this can provide a decent increase to the original value of the policy.
This is not the most effective way of earning based on interest or dividends, but it is an attractive feature that distinguishes permanent policies from term policies.
After a certain point, you will find that the annual amount earned from the policy is sufficient enough to cover some, if not all, of the premiums. This can happen with both interest earnings and dividend earnings.
At this point, you can elect for the income produced from the policy to automatically cover the cost of premiums, and you can redirect your attention to other avenues for estate planning.
Participating policies in particular are known to offer the option to trade dividends for an increase in coverage from your life insurance policy.
By doing this you can increase the death benefit that pays out to your beneficiary, further offsetting estate costs and providing more wealth for your heirs.
Creating an effective plan for producing income from a life insurance policy is difficult, but employing the help of an experienced professional can help. Contact Sim Gakhar today to set up a plan that will allow you to earn off your policy while also planning for your estate.
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