Non-Traditional Uses of Life Insurance

Non-Traditional Uses of Life Insurance

Life insurance is a powerful tool. As with other powerful tools, there are proper and improper ways to use it. Properly used, life insurance can help solve some of our financial life’s larger problems.

There are some problems for which life insurance is a great non-traditional solution. As with any other solution, the problem should dictate the solution; we shouldn’t be running around looking for ways to make additional uses for the solution.

Whether life insurance will be an appropriate solution, or part of the solution, depends upon your own circumstances.

Life insurance has a couple of unique characteristics. One is its creation of an immediate estate upon the death of the insured. This characteristic can’t be found elsewhere and is life insurance’s primary purpose for existence. Traditionally, this new estate is created for the purpose of providing financial resources for the surviving family. 

Second to the creation of capital where there was none, life insurance has specific tax advantages, which can make it useful in conjunction with its creation of an immediate estate. Here, in no particular order, are the major non-traditional uses of this versatile product.

Estate Transfer

People often have specific things they wish to have happen with their estate upon their death. And sometimes trying to do those things creates a problem. 

A farmer or business owner might wish to leave the operation to one or some, but not all, of their children. Often this is due to one child or several children having interest where the other or others don’t.

The owner may also wish to distribute the estate equally among the children, and the two objectives are often in conflict. If the farm or business is the major portion of the estate, there may not be enough estate to leave a financially equivalent portion to the others. 

Life insurance can be a great solution to this problem. A life policy can be placed on the owner, creating capital to balance the owner’s mutual objectives of leaving the existing major asset to one or some children while leaving a financially equivalent inheritance to the others. 

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Estate Costs

Federal estate taxes no longer hit the average middle-class household. But you don’t have to be ultra-wealthy either. Federal estate taxes aren’t the only estate cost concern.

Nineteen states have some form of estate tax, inheritance tax, or, in one case, both. In all cases, these taxes come into play sooner than the federal estate tax. But the governments aren’t done there.

Depending on the assets you leave to your heirs, there may or may not be a step-up in basis, wherein the value of the asset is readjusted for tax purposes. Without a step-up in basis, your heirs will pay taxes on your unrecognized gains. Retirement accounts, other than Roth accounts, are notoriously problematic. 

Often tax-deferred retirement accounts are an individual’s largest or second largest asset. (Typically, the largest will either be retirement accounts or the home; sometimes something else, but those are the big two.)

Plans like a traditional IRA, 401(k), or 403(b) don’t get a step-up in basis; the entire amount received will be taxable income to the beneficiary, which can be a lot of dough.

Life insurance can be a great tool to fund the certain and predictable erosion of your estate due to taxation and other costs. Life insurance can be a cheaper alternative to funding inevitable estate costs and allow for the entire value of your estate to pass to your heirs. 

College Funding

Life insurance can be a fantastic tool for college funding. It can also be a poor tool if not used correctly. 

Life insurance cash values grow tax deferred. If a policy is taken out on the life of one or both of the parents, it can be an excellent tax-advantaged college investment vehicle. Additionally, present rules don’t factor life insurance cash values into the family’s expected family contribution; it remains sheltered from affecting financial aid in many situations. Those are some strong positives.

There are also some strong cautions. If there is no insurance need on one or both of the parents, the costs may likely outweigh the benefits. You also need time; this isn’t a strategy that works well unless started when the child or children are young.

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Generally placing insurance on a young child is an ineffective way to build funds for a child’s education. It can work well when the insurance is on one of the parents — not the child. Cash value policies on young children are very inexpensive and only a portion of that small premium makes it into the investment side of the policy.

After 18 years, you might have enough money for books. Be very careful of using life insurance on children to fund their education; it rarely works. 

Succession Planning

Transfer of a partnership or small business upon the death of one of the owners can be a major challenge. If the partnership or business has been quite successful, the challenge can be even larger.

A typical succession scenario has one of a small group of owners dying. The intent is to transfer that share of the business to the remaining owner or owners, but it could be worth a sizable amount of money — perhaps millions. 

Small business owners frequently accumulate the majority of their wealth in the business. They reinvest into the business; it’s their major asset. There’s often not a lot of investment asset-building outside the business. 

Absent a funded succession plan, the remaining owners may find themselves suddenly part-owners with the deceased’s spouse or children.

This may or may not be a desirable outcome. Using life insurance is ideal for funding succession plans. It provides the necessary capital at the exact time it’s needed. 

Policies are often written on each business owner, with the other owners as the beneficiaries. An agreement stipulates the purchase of the deceased’s interest in the business at an agreed-upon price. The life insurance proceeds fund the purchase, extracting the deceased owner’s value from the business and passing that on to their heirs.

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Pension Maximization

Defined benefit pension plans are less common than they used to be but haven’t yet gone the way of the dinosaur. They’re still common in a number of occupations, notably unionized occupations such as teachers and police. 

Pensions provide multiple options for how the retiree receives their stream of income. They can select an option that pays only during their lifetime, with no remaining income to any survivor. This would typically provide the highest level of income.

There are also typically options to provide ongoing income for a surviving partner or spouse should the pensioner die first. The pension is reduced to provide for this additional benefit.

The most commonly selected pension option provides a benefit to the pensioner, and a 50 percent benefit to the pensioner’s partner or spouse should the pensioner die first. 

Knowing the pension numbers, it is easy to determine what lump sum of capital would be necessary to fund the pension beyond the pensioner’s death in this scenario.

You merely need to assume a rate of return you’re willing to work with and divide the annual benefit the pension would provide by that expected rate of return. This will yield the lump sum necessary to produce that benefit on an annual basis.

The next step is to determine if the reduction in pension benefit that funds the survivor benefit could instead be used to fund an insurance policy that would instead provide a lump-sum option.

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Funding the survivor benefit in this manner is pension maximization. Sometimes the reduction is ample to fund such a policy, and pension maximization is a viable option. Other times the reduction in pension to provide the spousal benefit is small and this technique won’t work. 

When the numbers support pension maximization, it can extract value from the retiree’s hard work building this benefit. It can provide greater benefit and increased flexibility for the retiree and their family.


Life insurance is also ideally suited to creating an instant legacy. Many people would like to provide something for organizations or institutions that have been meaningful in their lives. They would like to help that organization or institution continue to do so for future generations. 

There may be a conflict in that leaving this legacy depletes the assets available for the surviving family. Life insurance can either be used to create the legacy directly, or to replace wealth used to create the legacy. Taxes often help dictate which approach to use. 

In some situations, there isn’t a sizable enough estate to create the desired legacy. In this case, life insurance can create an estate where none existed, making the gift possible. 

The Bottom Line on Non-Traditional Uses for Life Insurance

Life insurance is a versatile and powerful tool. Like any powerful tool it needs to be used properly.

There’s a common theme to these non-traditional uses of life insurance.

In all cases, there’s a need for the death benefit, and there’s a need for insurance —the problem exists before the solution. 

We plan in a linear fashion. We have a problem or an opportunity. We apply a solution. We don’t go running around with the solution trying to find a problem to fit.

That’s what got life insurance its poor reputation; salespersons running around espousing insurance as the solution to every problem. It’s not. It is a great solution in specific instances where it makes financial sense. 

Insurance is also limited in the number of things you can expect an individual policy to do. If you’re trying to accomplish five or six goals with your life policy, that’s not likely to happen. 

If you do, however, have or anticipate having one of the problems described above, life insurance may be just the solution you need.

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