Life Insurance as an Investment

We are often asked by our readers “is life insurance an investment?”

The short answer is – YES, it is.

However, financial professionals may debate the merits of life insurance as an investment. Deniers accuse high loads, poor administration, and unrealistic illustrations, as proof these policies are better viewed purely as risk mitigants. It is true that the results of the transaction are largely dependent on the performance of the contract manager. And finding the right insurance to invest in can be a challenge for many investors. Insurance is a plan to protect more than to invest, and the investment options are limited.

But as I’ll describe below, it is hard to argue with the tax advantages associated with life insurance benefits. Life insurance policies can build up cash values tax deferred and then pay them out tax free. If an investor’s intention is wealth transfer, then perm life policy may make sense for tax and estate planning purposes.

Why I am a Proponent of Life Insurance Investing

The vast majority of life insurance is purchased for risk management. The death benefit provides cash in the event of an unexpected death. Cash can be used to pay off debt and provide survivor income. The tax benefits of life insurance allow a well-crafted whole life policy to be an excellent investment. Beyond the cash value, the death benefit policy can generate large savings.

It was an investment for me; one that I plan on benefitting from in the future. Several years ago, I purchased a whole life policy. The policy is designed to have low loads and high cash values. At the end of the first quarter each year, I write a premium to the insurance company. The cash value of this account will grow tax deferred.

My goal is to one day – in roughly twenty years – make a tax-free exchange of my policy into an immediate payout annuity. At that point, I will receive a monthly guaranteed amount that will pay my partner and I until we die. Further, the taxes on the cash values that I experience over the 20 years will be prorated over our life expectancy. If I perish during my working years, my partner will receive a substantial tax-free death benefit. I expect approximately a 7% after-tax internal rate of return on my premiums.

A life insurance policy is a way to tax-efficiently supplement monthly income in retirement years. The policy will defer taxes during high-income years, and then spread the income and the income tax out over lower earning years.

Perm Life versus Term Life

Permanent life insurance is an umbrella term for life insurance policies that do not expire. Perm life covers individuals for the rest of their lives and contains a cash value component. The two types of perm life are whole life and universal life. Whole life will offer coverage for the full lifetime of the insured and savings grow at a guaranteed rate. Universal life also has a savings element in addition to a death benefit. What distinguishes universal life insurance is it features different premium structures and earns a returned based upon market performance.

Premiums will go toward maintaining the policy’s death benefit and allowing the policy to build cash value.

The owner of perm life can borrow funds against the cash value, although there is often a waiting period before this may occur. Investors often forget that access to credit can end up saving them a lot of money over they years.

Perm life will enjoy favorable tax treatment as the growth of the cash value is generally on a tax-deferred basis.

*Remember that nonpayment of premiums can cause the policy to lapse.
Term life insurance is a temporary policy that many individuals use to cover themselves for a period of time. Term life typically requires lower premiums and is more affordable than permanent life insurance.  Term life promises payment of a specific death benefit for a specific period of years.

These policies have no value other than the guaranteed death benefit and feature no savings component.

Oftentimes, term life is convertible and can be renewed for another term plan or convert into a whole life policy.

Investors should consider a universal policy that offers permanent coverage as a place to invest extra capital.

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Life Insurance – Generation Skipping Transfer (“GST”) Taxes

As aforementioned, the death benefit policy has the potential to generate large savings. This is especially true for wealthy individuals using trusts to move large sums of money down through the generations. These individuals, and their families, pay large transfer taxes that charge a flat 40%: the gift, estate and generation skipping transfer taxes. Current laws allow an exemption of $11.4 million before these taxes apply.

A popular solution in GST tax exemption planning is life insurance. Life insurance has the advantage of paying exactly when needed and it pays a benefit that is income tax-free.

Here’s an example:

 A wealthy individual, Gen 1, uses his/her entire $11.4 million generation-skipping tax exemption to pay a one-time premium for life insurance. Assume the policy’s death benefit is $30 million and it resides in a dynasty trust. The trust is structured so that after Gen 1’s death, it collects the insurance proceeds income tax-free, and begins paying interest income to his/her children, Gen 2. The $30million principal in the trust will eventually go to the grandchildren, Gen 3, after Gen 2’s death.

Life insurance has maximized the leverage of this transaction. When Gen 1 died, the trust received $30 million income tax-free, and neither Gen 1 nor Gen 2 pay gift, estate or GST taxes on the death benefit. In the end, Gen 3 has $30 million in trust and the dynasty continues. Through this strategy, the family experiences little, if any, diminution in the value of their wealth through three generations.

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