There is an ongoing discussion in the financial industry regarding using life insurance as an investment vehicle. Permanent life insurance policies have numerous benefits over other investment vehicles which make them an attractive investment option when structured and funded properly. We will discuss below the argument for and against using permanent life insurance as an investment.
Permanent life insurance can be a great investment when the policy is max funded. Max funding the policy is industry lingo for putting the maximum amount of premium into the policy within IRS guidelines. When a policy is max funded, there is a surplus of cash value within the policy which can easily cover the cost of insurance and leave over plenty of cash value to grow and compound for your retirement. Indexed Universal Life policies grow at an average of 7% annually and the gains are tax free! Lets say you paid a total of $100,000 in premiums and you let the cash value grow from age 30 to 60, at age 61 you could have $750,000 in cash value! The cash value can be withdrawn from the policy at any time using policy loans (instead of actual withdrawals) in order to shield the gains from income tax.
Withdrawing using policy loans comes with additional benefits. Loans are not taxable as income which makes the gains within the policy shielded from state and federal taxes. Being that money is withdrawn using policy loans there is nominal interest accrual- policy loan interest rates usually max out between 4 and 5%. The cool thing is that since you don’t actually withdraw the funds but merely borrow it, the entire amount you withdraw still grows at average of 7%. That means even after you would start taking policy loans to supplement your retirement income, you would still earn an average of 2-3% on those funds.
An additional benefit of investing using life insurance is that IULs use a system of caps and floors to protect your cash value from losing value in a market down turn. This is quite important in our times with the market in its 11th year of a bull run and overdue for a 20% correction. While the floor is zero, the upside is capped between 10-13% meaning that if the market gains 16% the policy will be capped at 10-13% growth for that year.
While this strategy could work using a Whole Life policy, we don’t generally recommend this as Whole Life policies tend to max out at 3-5% growth so the cash value would grow a lot less, leaving less cash value available for retirement. While the difference between the 7% average growth in an IUL to the 3-5% growth in a Whole Life policy may not seem like much, when your dealing with compounding growth for 30 years the difference is astounding. Let say you paid a total of 100,000 in premiums and you let the cash value grow from age 30 to 60, at age 61 you could have $360,000 in cash value. That’s a whopping $390,000 less than the projected growth in an IUL! Considering a Whole Life policy max growth is 3-5%, buying term life insurance and investing the rest in a Roth IRA or a 401k plan will probably make more sense. Now the question why anyone would choose a Whole Life policy over an IUL policy we’ll leave for a another different discussion.
The key to using an IUL as an investment is being able to properly fund the policy. For those who don’t have the ability or discipline to properly fund the policy, the results can be less than desirable. If someone signs up for a $1,000,000 IUL policy and puts in $2000 for 3 years and stops paying premiums, the costs of insurance within the policy will likely eat up the cash value in the policy which will then cause the policy to lapse unless more premiums are paid toward the policy. Even if the policy is minimally funded, there can be just enough premiums to cover the costs of insurance and not much else, which means you got your life insurance covered but not much cash value left for your investment. Generally if you don’t have the funds to properly fund the policy, or if you have the funds but you are uncertain for how long you can keep the funds in the policy, in these scenarios it may make more sense to buy term life insurance and invest the rest.
To summarize, using permanent life insurance as an investment, may or may not make sense depending on your unique financial needs and monetary situation. If you still have doubts about which strategy is best for you or you would like more information on the topic, contact us for a no obligation consultation.