Today’s investors typically seek three things: safety, income and tax advantages. Unfortunately, there are few investments that satisfy all three, especially the desire for income at a satisfactory level. Investors who are in good health should look at the strategy of combining a high cash value life insurance policy with a single premium annuity to create the perfect tax-favored investment. This works especially well for older individuals.

High Cash Value Life Insurance (HCVLI)

High Cash Value Life Insurance (HCVLI) is an asset class that should be considered as a stable value investment. The primary purpose for HCVLI is for long-term, tax-deferred cash value appreciation and a tax-free death benefit. To be more specific, a whole life policy — issued by a highly rated mutual life insurance company — will provide both high cash value and death protection. The policy should be carefully designed, keeping the internal fees low in order to emphasize cash value growth.

The advantages of HCVLI in today’s economic environment:

  • Competitive Rate of Return – The annual return for a HCVLI can range from 3 to 4.5 percent over a five-year time period and is often greater than a 60-month CD.
  • Not Subject to Market Volatility – The cash value of insurance has no market correlation.
  • Eliminates Interest Rate Risk – When interest rates begin to rise, bond prices decrease. The cash value of a life insurance policy will not decline regardless of the movement in interest rates.
  • Tax Deferred Growth – The cash value grows tax deferred. Only when the investors take a distribution from the policy will they be subject to income taxes at ordinary income tax rates.
  • Liquidity – In most well designed policies, the investor can receive 100 percent of their deposit within 12 to 18 months. In the first year, the policy’s cash value will be less than the initial deposit due to policy acquisition costs.
  • Base Line Guarantees – In the event that the company eliminates their dividend and increases the internal costs, HCVLI has a guaranteed rate of return, which often is in line with a 12-month CD.
  • Tax-Free Death Benefit – In the event the investor never needs to access their cash value, at death the beneficiaries would receive tax free cash. 

Let’s look at a case study: Mrs. Fisker, a healthy 63-year-old woman, and her investment advisor have determined that $1 million of her overall portfolio should be in a stable value asset class. Mrs. Fisker does not need the interest from these funds to support her current lifestyle but may need to utilize them in the future. Her investment advisor recommends the Barclay’s 1-3 Year Credit Bond, which has a current yield of 2.4 percent and proven price stability.

However, after Mrs. Fisker pays income taxes on the interest earnings plus her advisor‘s annual investment management fee of .75 percent, her return is barely more than 1 percent. Let’s compare the Credit Bond to HCVLI from a highly regarded life insurance company with a history of paying dividends for decades. The first table illustrates the life insurance current dividend and internal costs of insurance; the second table is a worst case scenario.

Current Dividend

1-3 Year Credit Bond

HCVLI

Year

Credit Bond

2.4% Yield

.75% Fee

Taxes (30%)

Net Return

Year End Value

End of Year CV

Difference

1

$1,000,000

$24,000

$7,500

$4,950

$11,550

$1,011,550

$967,239

<$44,311>

2

$1,011,550

$24,277

$7,587

$5,007

$11,683

$1,023,233

$1,023,269

$36

3

$1,023,233

$24,558

$7,674

$5,065

$11,818

$1,035,052

$1,087,586

$52,534

4

$1,035,052

$24,841

$7,763

$5,124

$11,955

$1,047,007

$1,154,452

$107,445

5

$1,047,007

$25,128

$7,853

$5,183

$12,093

$1,059,100

$1,224,063

$164,963

6

$1,059,100

$25,418

$7,943

$5,243

$12,233

$1,071,332

$1,296,532

$225,200

7

$1,071,332

$25,712

$8,035

$5,303

$12,374

$1,083,706

$1,371,969

$288,263

8

$1,083,706

$26,009

$8,128

$5,364

$12,517

$1,096,223

$1,450,375

$354,152

9

$1,096,223

$26,309

$8,222

$5,426

$12,661

$1,108,884

$1,531,967

$423,083

10

$1,108,884

$26,613

$8,317

$5,489

$12,808

$1,121,692

$1,616,774

$495,082

 

Guaranteed Cash Value / Worse Case Scenario

1-3 Year Credit Bond

HCVLI

Year

Credit Bond

2.4% Yield

.75% Yield

Taxes (30%)

Net Return

Year End Value

Current Dividend

Difference

1

$1,000,000

$24,000

$7,500

$4,950

$11,550

$1,011,550

$940,860

<$70,690>

2

$1,011,550

$24,277

$7,587

$5,007

$11,683

$1,023,233

$968,996

<$54,237>

3

$1,023,233

$24,558

$7,674

$5,065

$11,818

$1,035,052

$1,001,739

<$33,313>

4

$1,035,052

$24,841

$7,763

$5,124

$11,955

$1,047,007

$1,034,983

<$12,024>

5

$1,047,007

$25,128

$7,853

$5,183

$12,093

$1,059,100

$1,068,707

$9,607

6

$1,059,100

$25,418

$7,943

$5,243

$12,233

$1,071,332

$1,102,869

$31,537

7

$1,071,332

$25,712

$8,035

$5,303

$12,374

$1,083,706

$1,137,465

$53,759

8

$1,083,706

$26,009

$8,128

$5,364

$12,517

$1,096,223

$1,172,406

$76,183

9

$1,096,223

$26,309

$8,222

$5,426

$12,661

$1,108,884

$1,207,636

$98,752

10

$1,108,884

$26,613

$8,317

$5,489

$12,808

$1,121,692

$1,243,049

$121,357

 

As you can see, based on the current dividend scale, HCVLI significantly outperforms Mrs. Fisker’s credit bond in all but the first year. Assuming the worst case scenario, HCVLI outperforms in all but the first four years.

HCVLI blurs the distinction often made between a typical life insurance policy, which is usually thought of as pure protection, and investments which are treated as accumulation vehicles. A properly structured HCVLI policy also provides a way for policy owners to access accumulated funds through loans or withdrawals at any time. This is a characteristic that sets HCVLI apart from nearly every other investment class.

Not only is HCVLI different, but it can produce a return that is just as favorable with less risk than the same portfolio without life insurance. If Mrs. Fisker should die along the way, a substantial benefit would pass to her loved ones. For example, in the first 10 years, the death benefit ranges from $2,221,430 (guaranteed) in the first year to over $2,809,758 in year 10. Investing in HCVLI is like having your cake and eating it, too.

Combining the HCVLI Policy with a Single Premium Immediate Annuity

As another example, let’s consider Jean, who is 82 and has a significant amount of her assets in CDs, money market accounts and credit bonds. Unfortunately, these assets are producing barely enough to keep up with inflation and the income from all three is fully taxable. To solve the problem, she transferred the following:

1. $500,000 to a HCVLI policy with a paid-up guaranteed death benefit of $676,822.

2. $176,822 to a SPIA.

The projected annual dividend payable to Jean from the HCVLI after tax is approximately $9,200 and the annual guaranteed, tax advantaged income from the SPIA is $21,221. This combined after-tax income represents a return of 4.5 percent. This is significantly higher than Jean was receiving after tax from her investments prior to the transfers.

After the annual dividends are paid to Jean from the HCVLI policy, the projected cash value is $481,149 at the end of Year 1, $504,525 at the end of Year 3, $526,000 at the end of Year 5 and is projected to increase annually thereafter. Jean can access any or all of her principal and terminate the policy at any time if it becomes necessary or desirable.

If Jean does not need to terminate the policy before her death, her family will receive the guaranteed tax-free death benefit of $676,822 — the total original amount deposited into the HCVLI and SPIA. While Jean is alive, she will continue to receive the guaranteed lifetime SPIA payments plus the non-guaranteed dividends form the HCVLI. 

Because of age and certain health issues, some older individuals believe they are not qualified to purchase insurance. However, this is not usually the case, as underwriting standards have changed in recent years and insurance companies have become more aggressive and allowed for “rated” policies. Many companies also write rated SPIAs, which means the annual guaranteed payout will be higher to the annuitant and, thus, provide a greater return.

When you examine this combination of HCVLI and SPIA as an investment strategy more closely, it is clear that it is an excellent investment alternative. Not only does it provide safety, significant income and tax advantages — the three things conservative investors seek — but also it provides peace of mind in challenging economic times.