Please ensure Javascript is enabled for purposes of website accessibility

How To Use Life Insurance for Savings and Investment

“Investors are pouring money into an old investment: life insurance. That’s right. Life insurance can be an investment. Before interest rates were deregulated a few decades ago, life insurance and pass-book savings accounts at the local bank were a major vehicle for saving and investing for many people. It became...

“Investors are pouring money into an old investment: life insurance. That’s right. Life insurance can be an investment. Before interest rates were deregulated a few decades ago, life insurance and pass-book savings accounts at the local bank were a major vehicle for saving and investing for many people. It became less popular after money market funds and other high-yielding alternatives became available.

“After more than 10 years of low interest rates and poor stock market returns, however, investors have been putting more investment money into life insurance attracted by safety of principal and guaranteed income. I’m talking about permanent or cash value life insurance. These are policies that combine the life insurance benefit with a cash value account. The traditional version is whole life insurance. The insurer pays an annual dividend that is credited to the cash value account. Dividends generally have a guaranteed minimum rate. The earnings of the cash value account are tax deferred. The insurer determines the amount of the annual dividend, based on its investment experience and expenses. Another form of permanent insurance is universal life, including variable universal life. The income credited to the cash value account can be pegged to investments selected by the policy owner or some investment benchmark, among other things. Universal life has the potential for both higher and lower returns than whole life. UL also allows the owner to change the death benefit, and premium payments are flexible within a range of minimum and maximum amounts. The insurance under UL is based on renewal term insurance, and costs generally are more transparent than for whole life.

“Permanent life is different from term life. A term life policy lasts for a stated period of years. The insured has the coverage for that period as long as the premiums are paid. After the term, the policy ends, and the policy owner doesn’t receive anything. There is no cash value or surrender value. Term life is to cover a specific need that is likely to end at a point in time. Term life is ideal for ensuring there is money to pay a mortgage or provide children with college education, to give two examples of obligations that end at a point in time. Permanent life provides for a continuing need, such as estate taxes or buying out the estate of a deceased co- owner of a business. Permanent life also can be used to provide a legacy for heirs. Many people now are using permanent life as both life insurance and their source of safe investments.

“There are several advantages of permanent life as an investment. The investment is safe as long as the insurer is financially solvent, and many of them have been around for over 100 years and invest more safely than banks. The dividend yields on cash value accounts are higher than bond yields these days and in the past have increased steadily in many policies. The minimum guaranteed dividend exceeds 10-year treasury yields in most policies. With variable universal life, you choose how the cash value account is invested from among funds offered by the insurer. You can do some of your stock investing through the cash value account. At some point, the cash value account can provide two advantages. The annual premiums can be paid from the dividends and the cash value. The insured can stop making premium payments, yet the policy will stay in force. This is sometimes called a vanishing premium policy. Another advantage is the cash value account can be a source of cash, often tax free. Permanent policies generally allow loans from the cash value, and the loans are tax free. The loan might not have to be repaid. The outstanding loan balance and accumulated interest will reduce the life insurance benefit paid to the beneficiary. You don’t have to take a loan to access cash. When you take a distribution from the cash value account, you withdraw your principal contributions first, and that is tax free. You pay income taxes only on withdrawals of the dividends and income. Of course, when an estate or heirs receive a life insurance benefit it is free of income taxes. Some people encourage the use of only permanent life insurance for investing and spending. Their strategy is to buy a whole life insurance policy, build up the cash value as much as possible, and use policy loans when you need money. Your savings compound tax-deferred, and you withdraw it tax-free as needed. ... You shouldn’t buy permanent life insurance as an investment unless you already need the life insurance. Otherwise, you’ll pay a lot of money for insurance you don’t need. The insurance need also should be permanent. Term life insurance is much cheaper than permanent life. ...

“To earn the benefits of permanent life insurance and avoid the traps, consider these steps: Buy permanent life insurance only when you need or want the insurance benefits. The insurance is too expensive to buy only for the investment advantages. Maximize your other tax-deferred and tax-free opportunities, such as 401(k) deferrals, IRA contributions and even deferred annuities. Be confident you’ll be able to pay the life insurance premiums indefinitely. Don’t plan on tapping the cash value account for a number of years. Ask agents or brokers about ‘blended policies.’ These are policies that more cleanly break out term life and permanent life, which results in lower costs and a faster build up of cash value. Agents earn lower commissions on these policies. Don’t put much faith in the policy illustrations. These are projections of future cash value and life insurance benefits based on assumptions about investment earnings and other factors. The assumptions usually are optimistic. ... Use cash value insurance as substitutes for your bond or fixed income investment allocation. Stocks and other risky investments for which you seek higher returns generally should be owned in taxable accounts where they qualify for the long-term capital gains tax break and losses can be deductible or offset gains. Look for low-cost policies. The Consumer Federation of America offers to evaluate policies for a fee at and generally favors universal life policies offered by TIAA-CREF.”

Bob C. Carlson, Bob Carlson’s Retirement Watch, August 2012

Bob Carlson is editor of the monthly newsletter, Retirement Watch. In it, he provides independent, objective research covering all the financial issues of retirement and retirement planning. Mr. Carlson also is Chairman of the Board of Trustees of the Fairfax County Employees’ Retirement System, which has over $2.8 billion in assets. He has served on the board since 1992. His latest book is Invest Like a Fox…Not Like a Hedgehog, published by John Wiley & Co. in 2007. His previous book was The New Rules of Retirement, published by John Wiley & Co. in the fall of 2004. Mr. Carlson has written numerous other books and reports, including Tax Wise Money Strategies, Retirement Tax Guide, How to Slash Your Mutual Fund Taxes, Bob Carlson’s Estate Planning Files, and 199 Loopholes That Survived Tax Reform.