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Life insurance investing

Life Health > Life Insurance

Life Insurance as an Investment: Is It Right for Your Clients?

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What You Need to Know

  • Permanent life insurance policies accumulate cash value as part of the premium payments.
  • Withdrawing or borrowing against the policy’s cash value can reduce the policy’s death benefit.
  • Using life insurance as an investment vehicle may not be the best choice for your client, but it can serve as a part of their investing strategy in some cases.

When most financial advisors and clients think about investing, life insurance is probably not at the top of the list. Stocks, ETFs, mutual funds and the like are generally the primary portfolio components for most of your clients. This is as it should be.

There are two main types of life insurance. Term life insurance has no cash value or investment component. Term life insurance offers a death benefit over a specified term.

Permanent life insurance has a cash value component. There are a number of cash value options across an array of cash value life insurance types. The cash value grows tax-deferred inside of the policy and can generally be accessed by your clients during their lifetime as a cash withdrawal or as a policy loan if needed.

Some types of permanent life insurance policies have features that can be attractive as an investment vehicle for some of your clients.

Does the Client Need Life Insurance Protection?

The main reason for most people to buy a life insurance policy is for the guaranteed death benefit that will go to their beneficiaries. Life insurance is an easy way to build or increase your client’s estate. It can also be a useful tool in your client’s estate planning strategy, providing a cash benefit to your client’s beneficiaries in the event of their death.

If your client doesn’t need the death benefit, then it generally doesn’t make sense to purchase life insurance solely for the investment features.

How Cash Value Life Insurance Works

Permanent life insurance policies include an investment component called cash value. A portion of each premium payment adds to the cash value of the policy, with the rest covering the cost of the insurance death benefit.

There are several varieties of cash value life insurance, and the split between the amount of each payment that is allocated to the policy’s cash value and the cost of the death benefit will vary by policy type and by the specific insurance company.

The cash value grows tax-deferred inside of the policy. Policy owners can borrow against this cash value. They can also withdraw from the cash value. These withdrawals are generally tax-free, but to the extent the withdrawal amount exceeds the policy’s basis, that portion may be taxed.

One important difference between the cash value of a life insurance policy and money inside of an annuity is that there is no penalty for taking a withdrawal prior to age 59.5 as there generally is with an annuity product.

Dividends, on policies that pay them, can be added to the cash value and allowed to grow. Or the dividends can be directed toward paying some or all of the policy’s premiums.

It’s important to note any amount of the cash value that is withdrawn from the policy or taken as a policy loan will reduce the policy’s death benefit.

Cash Value Life Insurance Policies for Investing

Whole life insurance features fixed premiums and a guaranteed death benefit. Cash value within the policy grows at a guaranteed minimum rate, which is typically on the low side. The premium level does not change over time. The premiums on whole life policies are typically pricier than other forms of life insurance.

Universal life insurance is another type of permanent life insurance policy. With universal life there is flexibility with the premiums and the death benefit. The interest rate on the cash value portion is generally in line with current money market rates.

Variable universal life insurance is similar to universal life insurance with the added benefit of offering underlying investment sub-accounts where the cash value of the policy can be invested.

These sub-accounts can go up or down in value like any other investment account.

Indexed universal life insurance is another form of universal life insurance. In this case, the return on the cash value is tied to the performance of an index like the S&P 500. Typically there is a cap on the amount of annual upside of the index the policy owner can earn. There is also usually either a minimum level of interest or a floor on the amount of loss the cash value can incur in a single year.

Variable life insurance is similar to variable universal life except that there is not the ability to adjust the premiums. These polices do offer investment sub-accounts for the cash value.

There are certainly other types of permanent life insurance policies beyond these five varieties.

Benefits of Life Insurance as an Investment Vehicle

Using cash value life insurance as an investment may offer some advantages for some clients.

Flexibility in Withdrawing Cash

Cash value life insurance policies offer more flexibility in getting cash than exists with an IRA, 401(k) or an annuity. With these retirement accounts, there will generally be a penalty if money is withdrawn prior to age 59.5. There are no early withdrawal penalties for tapping the policy’s cash value.

Policy Loans

Policy loans are also an option. While many 401(k) plans have a loan feature, these loans must be paid back or they become taxable. With a life insurance policy loan, the main downside is that the loan amount outstanding will reduce the policy’s death benefit.

You should also be aware that these loans will also accrue interest, bumping up the amount that must be repaid to keep the full death benefit in force.

Tax-Deferred Growth

For clients who have maxed out contributions to tax-deferred retirement accounts like an IRA or a 401(k), a permanent life insurance policy can be an alternative. The options to withdraw or borrow against the cash value offer a level of flexibility that other investment options may not offer.

Even with an investment held in a taxable account, selling shares of a stock, ETF or mutual fund could result in a capital gain or loss. In the case of a capital gain, the net amount received will be reduced by the taxes due. Realizing a capital loss will permanently reduce the value of the net proceeds from the sale of the investment.

Life Insurance Investing for a Child’s Education

There are a number of options for accumulating college savings. One option is a 529 college savings plan. You can also invest via a taxable account.

Using the cash value inside of a permanent life insurance policy to invest for college is another option. The cash value inside of the policy will grow tax-free. If the policy is a variable life policy, there are investment sub-account options available.

Once your client’s child is ready for college, your client can withdraw funds from the account or take a loan against the policy. In the case of a loan they can choose to repay it or go forward with a lower death benefit. If your client were to die before their child reached college age, the policy’s death benefit could be put toward the child’s education.

One consideration is the potential impact on college financial aid. In most cases colleges won’t hold the ownership of a cash value policy by the parents against the child’s financial aid application. However, any cash taken from the policy would count in the parent’s total assets.

Life Insurance Investing for Retirement

A permanent life insurance policy can play a role in your client’s saving and investing efforts for their retirement. The ability to access the cash value via a withdrawal or loan can be a source of cash as your client nears retirement. The investment options offered inside of some policies can help your client accumulate assets for retirement on a tax-deferred basis.

The policy death benefit can serve as a backup source of cash for a surviving spouse or other beneficiaries should the client die as they near or enter retirement.

Another strategy would be to take cash out of the policy and either stay with the reduced death benefit or let the policy lapse. In the latter case, you will want to work with your client to determine whether this would trigger any sort of tax liability, and if so, whether this course of action still makes sense.

The cash withdrawn or borrowed from the policy can be used to directly fund retirement expenses or can be invested elsewhere to cover future needs during retirement.

Things to Consider in Using Life Insurance as an Investment

When deciding whether life insurance as an investment vehicle makes sense for your client, here are some things to consider:

  • Do they need the death benefit from the policy? If yes, is a higher death benefit for their premium dollars a priority? If so then a term policy might be the better choice.
  • If the amount of withdrawals exceeds the amount of premiums paid on the policy, then this excess amount could be taxable to the policy owner.
  • Investment options inside of a variable policy may or may not represent choices that are on par with investment options available outside of the policy. If the investing goal is growth, then this might not be your client’s best option. These sub-account options may also come with relatively high expenses.

Some policies might be set up on a single premium basis or might allow the policy owner to accelerate their premium payments over a shorter time period than normal.

This can help to accumulate a higher level of cash value. If the policy becomes overfunded as determined by the IRS, it could be deemed to be a modified endowment contract and be subject to additional taxes and fees for early cash value withdrawals.

Whether life insurance is a solid investment option for your client will vary on a client-by-client basis.

(Image: David Palmer/ALM)


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