Life Insurance as an Investment: Is It Right for Your Clients?

Flexibility in Withdrawing Cash

Cash value life insurance policies offer more flexibility in getting cash than exists with an IRA, 401(k) or an annuity. With these retirement accounts, there will generally be a penalty if money is withdrawn prior to age 59.5. There are no early withdrawal penalties for tapping the policy’s cash value.

Policy Loans

Policy loans are also an option. While many 401(k) plans have a loan feature, these loans must be paid back or they become taxable. With a life insurance policy loan, the main downside is that the loan amount outstanding will reduce the policy’s death benefit. You should also be aware that these loans will also accrue interest, bumping up the amount that must be repaid to keep the full death benefit in force.

Tax-Deferred Growth

For clients who have maxed out contributions to tax-deferred retirement accounts like an IRA or a 401(k), a permanent life insurance policy can be an alternative. The options to withdraw or borrow against the cash value offer a level of flexibility that other investment options may not offer.

Even with an investment held in a taxable account, selling shares of a stock, ETF or mutual fund could result in a capital gain or loss. In the case of a capital gain, the net amount received will be reduced by the taxes due. Realizing a capital loss will permanently reduce the value of the net proceeds from the sale of the investment.

Life Insurance Investing for a Child’s Education

There are a number of options for accumulating college savings. One option is a 529 college savings plan. You can also invest via a taxable account.

Using the cash value inside of a permanent life insurance policy to invest for college is another option. The cash value inside of the policy will grow tax-free. If the policy is a variable life policy, there are investment sub-account options available.

Once your client’s child is ready for college, your client can withdraw funds from the account or take a loan against the policy. In the case of a loan they can choose to repay it or go forward with a lower death benefit. If your client were to die before their child reached college age, the policy’s death benefit could be put toward the child’s education.

One consideration is the potential impact on college financial aid. In most cases colleges won’t hold the ownership of a cash value policy by the parents against the child’s financial aid application. However, any cash taken from the policy would count in the parent’s total assets.

Life Insurance Investing for Retirement

A permanent life insurance policy can play a role in your client’s saving and investing efforts for their retirement. The ability to access the cash value via a withdrawal or loan can be a source of cash as your client nears retirement. The investment options offered inside of some policies can help your client accumulate assets for retirement on a tax-deferred basis.

The policy death benefit can serve as a backup source of cash for a surviving spouse or other beneficiaries should the client die as they near or enter retirement.

Another strategy would be to take cash out of the policy and either stay with the reduced death benefit or let the policy lapse. In the latter case, you will want to work with your client to determine whether this would trigger any sort of tax liability, and if so, whether this course of action still makes sense.

The cash withdrawn or borrowed from the policy can be used to directly fund retirement expenses or can be invested elsewhere to cover future needs during retirement.

Things to Consider in Using Life Insurance as an Investment

When deciding whether life insurance as an investment vehicle makes sense for your client, here are some things to consider:

Do they need the death benefit from the policy? If yes, is a higher death benefit for their premium dollars a priority? If so then a term policy might be the better choice.
If the amount of withdrawals exceeds the amount of premiums paid on the policy, then this excess amount could be taxable to the policy owner.
Investment options inside of a variable policy may or may not represent choices that are on par with investment options available outside of the policy. If the investing goal is growth, then this might not be your client’s best option. These sub-account options may also come with relatively high expenses.

Some policies might be set up on a single premium basis or might allow the policy owner to accelerate their premium payments over a shorter time period than normal. This can help to accumulate a higher level of cash value. If the policy becomes overfunded as determined by the IRS, it could be deemed to be a modified endowment contract and be subject to additional taxes and fees for early cash value withdrawals.

Whether life insurance is a solid investment option for your client will vary on a client-by-client basis.

(Image: David Palmer/ALM)