Is Life Insurance a Good Investment?
June 04, 2012Permanent life insurance has a whole host of benefits, especially for taxpayers in a high tax bracket, but does it make sense when you don’t have dependents? We got this question from one of our Facebook fans (yes- you can ask a question and we’ll answer it for you here.)
Here is her question:
“I am single, age 40 with no dependents (never will) and was just advised by a friend (and new financial advisor) to get life insurance as an investment. I make about 175k per year (post tax) and am self employed. I have been AWFUL about putting away money for my future and I want to get more responsible and do the right thing to maximize my investments. Any advice? Thanks much.”
Let’s start with the life insurance. Permanent life insurance has some great benefits – the cash value grows tax-deferred and there are ways to use the funds during your lifetime by making withdrawals tax-free either up to your basis (what you put in) or by using a loan provision. This type of life insurance also has either dividends (on whole life) or interest or market growth on universal life. These benefits are tied to the fact that it is a life insurance policy BUT you can’t forget there is a cost to the life insurance – it is not free!
If you don’t need or want the life insurance, then you are paying for something that has no value to you. For someone who has dependents, now that’s a totally different story. If someone needs the life insurance anyway, they are killing two birds with one stone but as you clearly state, that isn’t your situation. You are right to be skeptical. There are a whole host of other ways to invest for retirement and to build wealth that provide tax advantaged income and growth that don’t have an extra cost for a benefit you don’t need. Many whole life policies don’t even build any cash value during the first three years of the policy –they start accumulating cash value in the fourth year. If you don’t need life insurance, you just paid three years of premiums for nothing!
I actually have a whole life policy and I love mine because after the third year, my premiums go directly to cash value and because the policy earns higher than market rates, I watch the cash value steadily grow. Mine was earning over 5% the last time I checked so I see this as my “safe money.” Those premiums I paid for the life insurance will never go to waste since they will be paid out as a death benefit to my husband or my children in the future. But if you don’t need the death benefit, you just wasted a lot of money. There are much better investments for you.
Here are some investment ideas for investors in a high tax bracket:
Max out your pre-tax plans. In your case, you can ave a Simplified Employee Pension (SEP) plan for self-employed individuals. The maximum contribution is the lesser of 25% of salary or $50,000. (For employees with a 401(k) plan, the maximum contribution is $17,000 or $22,500 if you are over 50.) Put the maximum you can in this plan since it gives you a tax break now.
Open a Roth IRA. In your case, your income precludes you from investing directly in a Roth IRA but you can take advantage of a loophole using a two step process or as some call it a “back door Roth.” This works when you open a non-deductible traditional IRA for the maximum of $5000 (or $6000 if you are over 50) and then immediately convert it to Roth since there are currently no income limits to convert your traditional IRA to a Roth. For more information on this strategy, click here.
Consider tax-exempt bond funds. Municipal bonds are issued by cities, counties, schools, and state governments and the IRS gives investors a tax break to invest in them -a win/win for municipalities and for investors in a high tax bracket since they are exempt from federal income tax…and in some cases, state income taxes as well. Bonds can be purchased individually or through a professionally managed mutual fund. Who doesn’t love tax free? Learn more here.
Set up a systematic investment to your favorite mutual fund. Outside of your retirement accounts, you can still get favorable tax treatment when you hold your investments for over one year. Favorable long term capital gains rates are applied in that case – currently at 15% for investors in a 25% bracket (or higher) and 0% (none) for those in lower brackets. Now all that is set to change at the end of this year and go up to 20% and 10% respectively. That said, it is still lower! Lower is better.
Bottom line – always choose an investment based on the benefits to you personally and when you do choose one, set yourself up for success by automating it.
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