Should You Buy Life Insurance as an Investment?
January 08, 2015Should you purchase a whole or universal life insurance policy as an investment? We recently received several questions on our Facebook page on this topic so there seems to be a lot of confusion about it. On the one hand, many agents over-sell these policies as a way to earn big commissions. On the other, they can make sense for certain people. Let’s take a look at some guidelines to use to see if it makes sense for you:
How much life insurance do you need and for how long?
If you don’t have any dependents or a taxable estate (over $5.43 million in 2015), you probably don’t even need life insurance and you’re throwing those premium dollars away. If you do have dependents, you can use this calculator to estimate how much additional life insurance you may need. You then want to think about how long you will need the coverage (generally until your dependents should no longer be dependents). Permanent insurance like whole and universal life is most useful for situations like a special needs child or to pay estate taxes on an asset like a home or business that you don’t want your heirs to have to sell to pay the taxes.
Even if you need more insurance, one of the dangers of permanent life insurance policies is that they’re a lot more expensive than term insurance so you may not be able to afford to purchase enough coverage that way. Always make sure you can afford the coverage you need first before exploring insurance as an investment. That may mean combining a low cost term policy with a more expensive permanent policy.
What other tax-advantaged investment vehicles are available to you?
If you insurance and you can afford the premiums, the benefit of permanent insurance is that part of your premium goes into a cash value account that can grow or earn interest and be borrowed against tax-free. The outstanding loan balance is then deducted from the death benefit when you pass away. The downside is that typically high fees can reduce the return on that cash balance and even outweigh the tax benefit.
Before you purchase a permanent policy, make sure you’ve maxed out your other options. The closest would be a Roth IRA, which is tax-free after age 59 ½ and 5 years and allows you to withdraw the sum of your contributions at any time and for any reason without tax or penalty. Your employer’s retirement plan can allow to save for retirement pre-tax and possibly tax-free but there are restrictions on accessing the money before age 59 ½.
If you’re in a high-deductible health insurance plan, a health savings account lets you contribute pre-tax and make tax-free withdrawals for qualified health care expenses. Unlike health care flex spending accounts, whatever you don’t withdraw stays in your account. When you turn age 65, you can use the account penalty-free for any reason and tax-free for health care expenses.
Finally, there’s always the option of investing in a tax-efficient regular investment account. Individual stocks, ETFS, and low turnover mutual funds like index funds all generate very low taxes and there’s no penalty for early access. Their low fees can even make up for being taxable.
What are the fees and guaranteed returns?
If you do decide to consider a permanent policy, make sure you understand all the ins and outs as these can be quite complex. In particular, know all the fees, what returns are guaranteed, and the possibility that you might need to contribute more to the policy to keep it alive. That last point can be a serious problem for someone who can’t commit to the premium payments.
If you’re still not sure, you might want to consult an unbiased financial professional. The adviser selling you the policy obviously has a conflict of interest. If you don’t have an unbiased financial education provider like Financial Finesse at your workplace, you can hire an independent fee-only advisor through the Garrett Planning Network to consult with you at an hourly rate. Whatever decision you make, just be sure it’s an educated one!