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Life Insurance as an Investment Vehicle


Have you ever heard that commercial on the radio that’s advertising guaranteed investment returns of 5% even in down markets?  If you have, did you wonder what magical investment they were talking about?  Do you have no idea what I’m talking about because you just space out during commercials?  The last is probably most likely which is understandable.  Just don’t crash your car while you’re spacing out.

The investment vehicle they are talking about is actually…life insurance, more specifically universal or whole life insurance.  These types of life insurance require higher premium but build up a cash value that helps pay for higher costs of insurance as you age but keeps your premium stable throughout the contract.  This cash value can grow to be substantial over time.  The investment returns aren’t taxed (if the policy is designed properly) which is what makes it very attractive to investors.

So why don’t more people use life insurance as an investment vehicle and why is it such a secret?  This is a complicated question but in short life insurance is not designed to be an investment vehicle.  There was a time in the 70’s and 80’s when interest rates were high that life insurance was a popular investment vehicle.  This changed for two reasons.  1) The interest rates came crashing down forcing people to plug more money into their life policy or lose it.  Suddenly, the mortality cost (the cost of the life insurance portion of the policy) was eating up more than the interest rate could pay for and wrecking the cash value of the contract.  Many people were left with an expensive life insurance policy that left no cash value for retirement.  That’ll put a bad taste in your mouth.  2) The IRS changed how they view cash value life insurance.  They created standards for what was a life insurance policy and what was a Modified Endowment Contract (MEC).  Essentially, if your contract was more investment than life insurance (the cash value was too close to the death benefit or face value), you would lose the preferential tax treatment and all earnings would be taxed upon withdrawal of the funds.  Yikes.  You can see why these two changes crushed the use of life insurance as an investment.

Can you use life insurance as an investment today?  Yes, but be warned.  This is not the intent of life insurance.  Yes, you can get guaranteed rates of return of 4-5% and some companies will pay dividends as well.  The dividends are not guaranteed.  These can still have the same tax benefits, if designed properly.  However, you still need to pay the mortality cost out of your cash value which eats into your investment.  I would treat cash value life insurance more like a high yield savings account that you cannot have access to or a very, very long term CD (Certificate of Deposit) than a retirement investment vehicle.

Younger investors can also earn a higher rate of return through the stock market which has produced an average return of 7% since statistics have been kept on the stock markets performance.  The idea often suggested is to pass on cash value life insurance and buy term life insurance, then invest the difference in premium in stocks.  This should only be done after consulting with your financial advisor or extensive research on your part if you intend to handle your own investments.

So what’s the point of buying any of these policies?  Excellent question!  These policies are still useful in many situations.  Since they last as long as you continue to pay the premiums, whole life or universal life insurance can be an excellent product for children.  We cannot predict the future so it’s a great idea to guarantee that you child has some life insurance in case they develop a condition later in life that prevents them from getting life insurance.  In addition, if you buy the policy when they are young, the premium will stay low for their entire lives!  This makes it a much more affordable option down the road for the kiddos.  You can even design some policies to be paid up by the time they reach a certain age.

Another useful situation is estate planning.  If you have been very successful and need to plan on paying estate taxes, life insurance can simultaneously reduce your taxable estate and pay a tax free benefit to your beneficiary.  This is very important for high income earners with a large amount of accumulated wealth.  As for people who are not subject to estate taxes, a whole or universal life insurance policy can bet used to provide liquidity to an estate that doesn’t have liquid funds or doesn’t have enough funds.  This will help the executor settle the estate without liquidating real estate or property that is not easily marketable and has sentimental value.  It will also help with estates that do not have enough funds to pay funeral costs, medical bills, legal fees, etc.

Lastly, cash value life insurance policies can be used for charitable giving.  If you desire to leave funds to a charity upon your death, you can purchase a life insurance policy and designate the charity as a beneficiary.  The charity will receive the face value of your policy instead of the cash value which can be substantially more money.

In summary, I would caution people against using whole life insurance or universal life insurance as a retirement investment vehicle unless you know all the details of how these contracts work.  Consult your financial advisor, insurance agent and accountant so you know how your total financial plan will be affected.  There are millions of opinions on how to best save for retirement so do your research and pick the option that is best for you.

If you’re interested in any life insurance, contact the Frederick Agency today at 419-732-3171 and one of our licensed agents will be happy to help you find the right contact for your needs.

By Brennan Madison, CPCU, CLU

Posted 1:18 PM

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