Why is insurance important in financial planning?

Insurance is designed to protect the financial plan you’ve worked hard to build. It transfers life's worst-case scenarios, such as a death, disability or major loss, to an insurer, creating a safety net so one event doesn't derail your savings, retirement or estate.

Done well, insurance also has the potential to diversify your portfolio, add predictability and reduce your tax burden.

Why should insurance be part of your financial plan?

Insurance can play many roles in your financial plan, including portfolio diversification, added predictability, tax advantages and risk mitigation. Each one helps build a stronger financial foundation. Think of it as the protective layer that keeps your other goals on track.

“Financial planning in general is not a one-and-done transaction, and insurance shouldn’t be either,” notes Jacob Kujala, senior product manager with U.S. Bancorp Advisors. “A good financial plan takes into consideration your income, investments, goals and concerns, and then is continually monitored. Insurance should follow that plan.”

How does insurance help mitigate risk?

The most common reason to own life insurance is to reduce risk. If your family’s primary income provider passes away, life insurance can help fill the resulting financial void. But it can mitigate risk in other ways, too.

Consider this comparison. Suppose you invest $10,000 a year for 10 years in a traditional investment versus using that amount to “overfund” a $200,000 cash value insurance policy. With the traditional investment, if you unexpectedly pass away after two years, your heirs receive the $20,000 you invested. With insurance, your heirs receive the entire $200,000 death benefit.

Life insurance shouldn't be your only risk tool, though.

“Having cash value life insurance is the third leg of the stool,” Kujala says. “It can become very beneficial down the road, but only when it’s used in combination with other investment tools.”

Disability coverage deserves more attention than it usually gets. “Disability is one of the more overlooked insurances,” Kujala says. “Your average working individual generally relies on their employer-provided disability. But in a lot of instances, especially for highly compensated individuals who get compensation in terms of stock options, etc., having your own personal coverage to supplement that should be discussed within financial planning.”

Long-term care insurance also deserves a place in your plan, Kujala notes, and you have several options. Traditional long-term care insurance is one. Repositioning assets so they're available if needed for care is another. A third is acquiring a life insurance policy with accelerated benefits for long-term care.

Different policies guard against different risks. Here's how the main types of insurance protect your plan:

How does insurance diversify your investment portfolio?

Cash value life insurance is a permanent policy that builds a savings component you can access during your lifetime. It can add tax-deferred growth to your overall strategy. If you're in a higher tax bracket and have already maxed out your qualified retirement plan contributions, this gives you another place to grow money.

When you need it, you can draw your basis without paying tax, because you're simply taking back your own money. From there, you can switch to policy loans, which aren't reportable income.

"It ends up being a de facto tax-free distribution on the back end," Kujala says. "It helps with income tax reduction and management while it's growing, and then potentially when you're taking money out on the back end as well."

How does insurance add predictability to your financial plan?

Life insurance brings welcome consistency to your legacy and estate plan. Investments, real estate, business interests and other assets rise and fall in value over time. A life insurance death benefit doesn't change drastically, so that piece of your estate plan stays steady. That predictability makes the rest of your planning easier.

What tax benefits does insurance offer?

A well-planned insurance strategy can deliver meaningful tax advantages. In most cases, the death benefit of a life insurance policy is income tax-free for your beneficiary. For individuals with significant wealth whose heirs would face a federal estate tax, or who live in a state with its own estate tax, placing a policy inside an irrevocable trust can help avoid estate taxes. An irrevocable trust is a legal arrangement that moves assets out of your taxable estate and can't be changed once it's set up.

"Doing that creates an asset that becomes income tax-free in terms of the death benefit and becomes estate tax-free because it's owned in an irrevocable trust outside of your taxable estate," Kujala explains.

What are your options to fund life insurance premiums?

Insurance plans are customizable, and so is the way you pay for them. Your premium is the amount you pay for a given policy, and you can tailor how you cover it.

The simplest source is cash. You might also free up cash by reducing holdings or selling existing stock positions. Income from assets gifted to family members, such as investment real estate, is another route. Liquidating assets works too, though it may carry tax implications.

Financing your premiums is an option if you'd rather not part with assets to cover large payments. Premium financing means borrowing money to pay your policy premiums instead of selling assets to cover them. Life insurance premium financing can suit a family with accumulated assets that would face a large estate tax once passed to heirs, including investments, privately held businesses or real estate.

How often should you review your insurance policies?

Review your insurance at least once a year, as part of your annual financial plan review. Policy performance fluctuates over time, often with interest rates, so it pays to stay current. Other elements deserve a look too, including ownership and beneficiary structures, exposure to negative tax treatment and how competitive your policies remain.

A thorough analysis may uncover more attractively priced policies, stronger guarantees and additional policy features. Major life changes, such as getting married or starting a business, can prompt revisions as well.

“In addition to making sure you’re getting the right amount of coverage and the most cost effective, it’s also important to review the ownership of the policy and the beneficiary designation for the policies,” Kujala adds.

Frequently asked questions

How can insurance help you meet savings goals?

A cash value life insurance policy can grow tax-deferred, giving you another place to build money once you've maxed out qualified retirement accounts. You can draw your basis tax-free, then switch to policy loans, which aren't reportable income. That makes it a useful complement to your retirement and savings strategy.

What types of insurance belong in a financial plan?

Life insurance, disability insurance, long-term care insurance, health insurance and property coverage like auto and home all play a role. Life insurance replaces income and supports your estate plan. Disability insurance protects your earning power, and long-term care coverage helps with late-in-life expenses.

How often should I review my insurance?

Review your policies at least once a year, alongside your annual financial plan review. Also revisit your coverage after major life changes, such as marriage, a new business or a shift in your assets. Regular reviews help you confirm the right coverage, competitive pricing and accurate beneficiary designations.

Take the next step in insurance planning

There are as many types of insurance plans as there are people who need them. Approach buying insurance from a planning perspective, not a transactional one. Your situation is one of a kind, and your coverage should reflect that.

“Properly structured insurance portfolios are unique and should be individualized to your situation,” says Kujala. “Your estate plan, your legacy and your wishes after you’re gone must be taken into consideration.”

Ready to put insurance to work in your plan? Learn more about insurance protection through U.S. Bancorp Advisors.