Since you don’t see the immediate benefit, life insurance is often forgotten as a way to earn passive income. The best way to think about it is to categorize it among your retirement accounts which can grow in value tax-deferred as you invest in it but does have withdrawal rules that must be followed. There are a number of options with life insurance so you should consult with an insurance broker/agent to meet your needs.
What is Life Insurance?
Insurance companies offer to send you or your loved ones money in the event of a particular incident to handle the expenses associated with it, in this case your life! For access to this money, you will pay a subscription fee (called a premium). You have the option to have access for the amount (say $1 million dollars) to be paid out if you die within 10, 30, or even 40 years, depending on the term of your life insurance policy!
Your age and health are factors that contribute to determining your premium amount. Assuming you’re the picture of health, you could be paying as low as $19/month for this death benefit if you meet the insurance company’s criteria. This is considered term life insurance, is usually the cheapest option, and does not offer passive income, but it’s a great safety net to have in place for your loved ones.
The 2 other options we will discuss here are Whole Life and Universal Life insurance which offer a death benefit (money paid out upon death), but the premiums are higher and are partially saved/invested.
Whole Life Insurance
Whole life insurance also guarantees the death benefit, fixed premiums, and cash value growth. A big difference is that while the premiums are higher, part of the premium is placed into a cash savings account as part of your policy. Another difference is that this insurance is not for a particular term of time (10 years, 30 years, etc.), it’s your whole life….get it?
Universal Life Insurance
You could change the word “universal” to flexible or adjustable and that might help you remember the differences. With this type of insurance you can change the amount of your death benefit throughout your life and the premiums will change along with it. You also can pay your premiums, within certain limits, at your own pace. Similar to whole life insurance, part of your premiums are put into a savings account. As it accumulates you may even be able to pay your premiums from that savings account if there’s enough saved.
How Does This Grow My Passive Income?
As mentioned in the bank accounts, stocks, and mutual fund articles, buying assets that pay you a dividend or interest payment, as long as they are in business, for just buying or putting your money in them is one of the lowest effort ways to produce income.
Since life insurance policies put part of your premium into a savings account, depending on the insurance company, you may be able to “participate” in the financial performance of the firm.
Participating life insurance companies will pay a dividend to policyholders (i.e. 6% annual dividend on $10,000 cash value = $600) that is non-taxable if the dividend isn’t more than the premiums you’ve paid. Universal life insurance dividends are based on interest rates while other life insurance policies can be “indexed” to the stock market. You can choose to reinvest dividends in the policy savings account and continue to build it up, take it as a tax-free distribution, put it towards premiums, or to buy even more life insurance!
Why Would I Want This Passive Income Stream?
Your employer may or mayn’t (yes, it’s a word) have subsidized life insurance options for you as part of your benefits package. You may be buying outside life insurance anyways to better protect you and your loved ones, so why not keep some of the premiums you are already having to pay? On top of keeping some of the premium, depending on the insurance company and policy you go with, the ability to passively grow that portion that is put into a cash account is a huge bonus (especially when your investment portfolio is experiencing capital losses). This cash value becomes an asset to you since you have options to use that cash value as an emergency fund or as collateral for a loan.
Leveraging, or taking a loan, against the cash value of your insurance policy can give you 2 things, either a personal loan from the insurance company instead of withdrawing the actual cash (withdrawals can have fees) to cover personal expenses or as an opportunity loan in which you can invest in another income producing asset: real estate, private lending, business acquisitions, etc! If you are disciplined, you can essentially become your own bank! Paying back the loan will potentially allow you to continue to put more money into your cash account which can continue to be an asset to you if the need arises, all while having insurance! As the analogy goes: 2 birds, 1 stone.
Risks & Considerations
Just like most investments, while some offer guarantees but slower opportunities for growth, others offer no guarantees but opportunities for faster growth. Whole life is on the low risk side of the spectrum while Universal or Indexed policies are on the higher risk side of the spectrum, but that doesn’t mean they are bad (obviously people buy them or else they wouldn’t be an option).
One of the risks is that if the cash value is associated with interest rates or another market indicator, you may need to pay a higher premium to make up the difference. If the cash account is underfunded and can’t be brought to balance, the policy can be terminated. Downturns in the market happen but only a few are ever devastatingly low. The other side of the story can be illustrated with the 10 year period after the 2008 financial crisis before we saw another meaningful decline in markets. Accounts indexed to the US stock market (mutual funds/ETFs, stocks, life insurance, etc.) during that time would have earned much higher returns than a high yielding cash account. As previously mentioned, it is worth talking with an insurance broker.
If you work in the United States, PolicyGenius is a company that will help you find the right policy to meet your needs without trying to pressure you into a specific policy. If anything, they may try to help you get more or bundle insurance to find options to save money but that is up to you to figure out how much you need given your health, age, dependents, investment goals, etc.