Can Life Insurance Have Value as An Investment?

Now consider this scenario. You acquire a $101,000 life insurance policy with a $100,000 deposit. The annual earnings less the true costs of the $1,000 “at risk” (the amount the insurance company is at risk over and above your deposit) could be obtained through tax-free life insurance zero net cost loans. Would that also be attractive? It should be, because it is the same thing. When comparing the $50 cost in this example to the tax implications of an 8% gain on $100,000, the difference is proportionally staggering, especially when compounding that year over year.  

The problem with my question however, is that since TAMRA, TEFRA and DEFRA legislation came to be in the 1980s, we cannot have that any more. You cannot immediately deposit $100,000 into a $101,000 policy.  You can, however, work your way into that scenario over time.

Since there is apparent value once you would arrive at that point, the obvious question then becomes, “What does it cost you to get there?” Keep in mind when we look to obtain our goal in this scenario, we are really trying to minimize the amount at risk, or the insurance element, as much as the regulations will allow us to, in order to minimize the erosion to our return from insurance costs. For many, the alternative erosion comes in the form of income taxes, capital gains taxes or a combination of the two. So it then comes down to a choice of tax erosion or erosion of insurance costs.

In our office we’ve created a spreadsheet to help analyze the true annual insurance costs. Once costs are determined, we then compare those costs to the erosion to an investment that would come from paying income taxes on the assumed gains, using various tax rates. Utilizing a level death benefit product and putting as much inside the contract as the regulations allow, we find with consistency that the insurance costs erosion annually tends to level out, and then decline as the cash value grows and the amount at risk shrinks. The tax erosion, on the other hand, will grow continually as a taxable account value grows. Using a spreadsheet to illustrate an 8% return and a 28% tax rate, it is quite common for the tax costs to start exceeding the insurance costs within the first 4–6 years. The spread between the two gets wider each and every year.  

The easy question I ask my client who has a good amount of long-term investment funds in a taxable account is, “Would you prefer erosion to your earnings as a result of paying taxes, or as a result of paying the insurance company and having a benefit for your family should something unexpected happen?”

My philosophy is that the tax benefits of life insurance as an investment are only bested by a Roth IRA or Roth 401k. I also believe that, for a life contract to be efficient, it is essential to determine its purpose. If it is for protection, we should be acquiring the least expensive product we can that meets our protection objectives and timeline. This usually means term insurance. If it is for tax-advantaged investment purposes, we should be looking to minimize the protection benefit of the contract as quickly as we can, to get erosion to the overall yield by insurance costs to its lowest level, and thereby maximize the return net of all costs. In other words, we should be depositing every dime we can as allowed by the regulations, and as quickly as we can. Gone should be the days of advisors trying to sell it both ways, as protection and an investment. This approach delivers both overpriced insurance and inefficient investing.