Permanent Life Insurance or Mortgage Payoff?
August 20, 2015We recently received a question on our Facebook page from a couple in their 50’s who are trying to decide between a fixed universal life insurance policy with a quoted return of “7% minus fees” vs paying off a mortgage with a 3.5% interest rate. This combines two common question topics: using permanent life insurance as an investment and paying off a mortgage early. Let’s take a look at some things to consider:
1) Do you need life insurance? Remember, the main purpose of life insurance is to provide for anyone who is financially dependent on you. If your children are on their own and your spouse is financially independent, you probably don’t need life insurance and the money used to pay those premiums can be put to better use elsewhere. Why pay for something you don’t need?
2) What’s the return net of fees? A 7% fixed return sounds pretty good and may be too good to be true. Whenever you invest in anything, make sure you understand all the fees involved. Cash value life insurance policies can be particularly complicated so you’ll want to make sure you get an idea of the return you can expect AFTER all the fees have been deducted.
3) What are your alternatives? Once you know what return you can expect, you’ll want to compare that with what else you can do with the money. First, make sure you’re getting the full match on your employer’s retirement plan because otherwise that can be a 50% or even 100% instant return. No other investment can match that.
Second, see if you can pay off any debt with a higher interest rate than the return you expect to get. In this case, the 3.5% rate on the mortgage is pretty low and it’s also tax-deductible so paying it off early may not make sense. However, paying off a credit card with an 18% interest rate is like getting a guaranteed return of 18% on your money.
Finally, compare the return with what you can reasonably expect to earn by investing it somewhere else. This is where your risk tolerance will come into play. If you’re an aggressive investor who would invest about 80% in stocks, you might be able to expect a 6% average annualized return. But if you’re a more conservative investor who would invest about 35% in stocks, your expected return may be closer to 4%. Keep in mind that if you’re investing in a taxable account, you’ll also want to reduce that return to account for taxes. (In that case, paying off the mortgage may look more attractive for a conservative investor.)
4) Where can you go for unbiased help? If you want more personal advice or guidance, you may not want to ask the agent selling the life insurance policy for help because they have a vested interest in selling it to you and they may not even be trained to know about other investment options. Instead, see if your employer offers an unbiased financial wellness education or coaching program. If not, you can search organizations like the Garrett Planning Network, the XY Planning Network, or the Alliance of Comprehensive Planners for financial advisors who don’t sell insurance or investments and instead provide advice for a hourly, monthly, or annual fee, respectively. An hourly rate can be especially fitting if you just want advice on this one topic.
How about you? Do you have any financial questions that you’d like to get an unbiased professional answer on? If so, you can submit them to our Facebook page for one of our planners to answer or directly to me in the comments section below.