Life Insurance Articles
Life Insurance As An Investment
Article 6 of 9 in Getting the Right Life Insurance Policy
Life insurance can do more than provide a death benefit at the end of life. It can also help you plan your financial future by developing a savings or investment account. Term life insurance will only provide a death benefit, but permanent life insurance variations such as universal or variable life insurance policies are geared not just towards providing a death benefit, but helping to build your financial portfolio.
TIP: Using life insurance as an investment can be tricky. It is best to talk with a reputable agent or financial advisor about life insurance financial planning in order to determine which life insurance product is best for you.
Understanding Universal and Variable Life Insurance
Before you know if investing in life insurance is right for you, you first have to understand the types of life insurance that offer investment packages. Each has its advantages and disadvantages that you should know before you decide to purchase one.
- Universal life insurance is a permanent life insurance with a death benefit and a savings account. This added flexibility can be advantageous as this cash component allows you can stop making premium payments (or make reduced payments) as long as the cash value supports the premium of the insurance portion. In addition, you may also be able to increase or decrease the death benefit over time. You can usually borrow against the policy in the form of a loan should you need a quick cash infusion.
- Variable life insurance is a type of whole life insurance policy that also has an investment portfolio attached. The cash value is invested in your choice of stock, bond, or money market funding options. Cash values and death benefits vary based on the performance of the portfolio. Although death benefits usually have a floor, there is no guarantee on cash values. While this may be an answer to the lower returns offered by universal life insurance policies, fees for these policies may be higher than for universal life and you are taking the risk that your investment returns could be low. If this happens, it could eat into your death benefit. On the other hand, capital gains and other investment earnings accrue tax deferred as long as the funds remain invested in the insurance contract. Therefore, if your investments do well, you could have tremendous gains as well as have a huge increase in the death benefit!
Tax Advantages of Life Insurance as an Investment
There are some tax issues to consider before using life insurance as an investment:
- Death benefits are generally not taxable as income to a person named as the beneficiary. When you die, your beneficiaries will collect the death benefits and proceeds of the policy that have accrued tax free.
- Cash value grows over time tax free, and you can take tax free loans or withdrawals. Any dividends grow in the policy are also tax free. The amount of dividend applied to each type of policy is determined each year by the company based on the financial results of the preceding year. The dividends can also be considered as a return of part the premium paid for the life insurance. The policyholder can elect to receive the dividends in cash or have them applied to reduce the policy premium, or added to the policy as paid up additional life insurance.
- You can gift a policy by contacting the insurance company you can make an absolute assignment of the policy. The person to whom you assigned the life insurance policy then becomes the owner. You should check with your tax advisor to find out if the gift makes you responsible for paying gift taxes
TIP: As with all tax and estate matters, if you have specific questions you can contact an experienced life insurance agent or an attorney for further information. You should consult a professional before you make any decisions.
Creating a Life Insurance Trust
A life insurance trust is a trust that is set up for the purpose of owning a life insurance policy. This has many tax advantages. If the insured is the owner of the policy, the proceeds of the policy will be subject to estate tax when he or she dies. Transferring ownership to a life insurance trust will make the death benefit proceeds completely free of estate taxes. This tax advantage can add up to thousand upon thousands in savings.
In lieu of setting up a trust, you give up the right to change the beneficiary of the policy (the trust itself will be the beneficiary). You have to appoint a trustee of the trust and he or she has that right to run the trust and dictate how the funds will be used. The insured cannot serve as trustee of his own life insurance trust. The insured will designate the beneficiaries of the trust itself (for example, your children).
This designation cannot be changed after the life insurance trust has been set up. Therefore you lack the flexibility in the event family circumstances changes. Any change usually requires attorney action and therefore will be done at a cost.
Ask for a Life Insurance Illustration
When shopping for a policy, ask your insurance company or agent for an illustration. A life insurance illustration is an outline that will project the expected performance of the policy under certain conditions. It will show you that if you pay your premiums on time and at a certain rate of dividends, under a certain interest rate, you should reap a certain amount of cash value by a certain date. It will also show you when you can stop paying your premium and the paid up amount of cash value will then take over paying the premium for the death benefit.
TIP: Read the fine print carefully. Take into consideration any assumptions made in the illustration. Ask questions if you do not understand and make sure before you sign you comprehend any projections that are being made.
Value of Life Insurance as Savings
Even though there are alternative benefits to life insurance, you will still need to be sure that you should take advantage of them. At the end of the day, cash value life insurance generally grows much slower than a separate investment account and does not accumulate until you have paid premiums over a few years. Therefore, it could be a long time before you earn an amount that is greater than your monthly contributions to a saving account or money market account. Further, although Universal Life and Variable Universal Life provides a saving plan that is attached to the life insurance, if you stop contributing to your premiums for the life portion and run out of money in the cash accumulation fund, you can find yourself without a cash saving AND life insurance.
To determine if using life insurance as an investment is right for you, find a life insurance agent that will review your current and future goals. He or she will conduct a need analysis review to determine if you are adequately insured for life insurance and your risk tolerance for investing in life insurance. You can also talk with an estate planning attorney about creating a life insurance trust to help pass on your estate. Once you have decided on a life insurance policy that meets your needs, click here to get a free life insurance quote from Free Advice.
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