Investing in life insurance: is it right for your clients?

Flexibility in cash withdrawal

Cash value life insurance policies offer more flexibility for obtaining cash than is available with an IRA, 401(k), or annuity. With these retirement accounts, there will usually be a penalty if the money is withdrawn before age 59.5. There are no early withdrawal penalties for exploiting the cash value of the policy.

Policy advances

Policy advances are also an option. While many 401(k) plans have a loan feature, these loans must be repaid or they become taxable. With a life insurance policy loan, the main disadvantage is that the unpaid loan amount will reduce the death benefit of the policy.

You should also be aware that these loans will also accrue interest, which will increase the amount that must be repaid to keep the death benefit in effect.

Tax-deferred growth

For clients who have maximized their contributions to tax-deferred retirement accounts like an IRA or 401(k), a permanent life insurance policy may be an alternative. Withdraw or borrow against cash value options provide a level of flexibility that other investment options may not.

Even with an investment held in a taxable account, the sale of stocks, ETFs or mutual funds could result in a capital gain or loss. In the event of a capital gain, the net amount received will be reduced by the taxes due. The realization of 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 education savings. One option is a 529 college savings plan. You can also invest through a taxable account.

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

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

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

Life insurance Investing for retirement

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

The policy’s death benefit can serve as a backup cash source for a surviving spouse or other beneficiaries if the client dies nearing or entering retirement.

Another strategy would be to withdraw money from the policy and keep the reduced death benefit or let the policy expire. In the latter case, you will want to work with your client to determine if this would trigger some sort of tax liability and, if so, if this course of action still makes sense.

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

Things to consider when using life insurance as an investment

When deciding if life insurance as an investment vehicle is right for your client, here are some things to consider:

  • Do they need the policy death benefit? If so, is a higher death benefit for their premiums a priority? If so, a long-term policy might be the best choice.
  • If the amount of withdrawals exceeds the amount of premiums paid on the policy, this excess amount may be taxable to the policyholder.
  • The investment options inside a variable policy may or may not represent choices that are on par with the investment options available outside the policy. If the investment objective is growth, this may not be the best option for your client. These sub-account options can also lead to relatively high expenses.

Some policies may be issued on a single premium basis or may allow the policy owner to accelerate their premium payments over a shorter than normal period.

This can help accumulate a higher level of cash value. If the policy becomes overfunded as determined by the IRS, it could be considered 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 from client to client.

(Photo: David Palmer/ALM)

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