Is cash value life insurance a good savings vehicle?
By Lew Nason
Insurance Pro Shop
If you have clients who need life protection for their families, is cash value life insurance a good savings vehicle to explore? It might be the question of the ages!
Over the past 40 years or more there have been a lot of questions, discussions and heated debates as to whether or not buying permanent life insurance makes sense. The primary argument generally revolves around whether a client will have more money when buying permanent life insurance compared to using some other investment vehicle. However, there is much more involved than just how much money they'll have, such as: How long will they need the insurance protection? What do they want the money for? How long before they will need the money? What income tax bracket will they be in when they retire?
In this brief article we're only going to focus on what seems to be the primary issue for most people -- whether or not clients will have more money when buying permanent life insurance when compared to other investment vehicles.
So, the first question is, what are they comparing the cash accumulation in the cash value life insurance to? Are they buying term and investing the difference in mutual funds, stocks, qualified plans, non-qualified plans, municipal bonds, corporate bonds, government bonds, Treasury certificates, mortgage notes, CDs, etc.?
Most people are being misled into believing that by investing in the stock market or mutual funds they can earn an average annual return of 10 percent, and that cash value life insurance returns will average only around 4 percent to 6 percent. Logically, an investment that averages 10 percent is going to accumulate a lot more money than something earning only 4 percent to 6 percent.
Unfortunately, the comparison of investment returns isn't that simple. There are grandiose claims, much misinformation, and important information to sort through and consider; such as actual realistic investment returns, annual fees and expenses, withdrawal penalties, income taxes, tax deferral, tax-free income, cost of insurance, internal rates of return, ages, health rating, smoker, non-smoker, male, female, etc. These are all extremely important points for you to consider with your clients when determining if buying permanent life insurance makes sense for them.
Let's assume your client is a 45-year-old male. He needs and wants $250,000 of life insurance. He's a non-smoker, in good health, and has $6,000 to spend each year for the next 20 years.
If 20 years ago he had purchased a 20-year term policy with $250,000 of death benefits, the policy would have cost him about $760 per year. That would have left him with about $5,240 remaining to invest each year. The question is, where would he have invested that money?
How about if he had invested in growth mutual funds inside of a 401(k) or IRA, like most people did?
Let's take a look at the past 48 years to put investing in growth mutual funds into proper perspective.
- In the 1960s the S&P 500 Index had an average annual return of 4.39 percent over those 10 years.
- During the '70s the S&P 500 Index had an average annual return of 1.60 percent over those 10 years.
- In the '80s the S&P 500 Index had an average annual return of 12.59 percent over that decade.
- In the '90s, we had one of the best times in the history for the U.S. stock market. The S&P 500 Index had an average annual return of 15.31 percent.
However, when you consider that the vast majority of mutual funds didn't even come close to matching the S&P 500 Index over those 40 years, and then you subtract the annual fees of 2.5 percent to 4.05 percent, it gives you an entirely different view of the validity and benefits of investing in mutual funds.
And, we haven't even considered that from the beginning of 2000 through 2008, the S&P 500 Index had a total loss of -38.53 percent, or an average annual loss of -5.90 percent over those eight years.
If you add in the history of the last eight years, the average return for the S&P 500 Index over the past 48 years is only 5.82 percent. Now, subtract average expenses of 3.0 percent and the net return becomes only 2.82 percent. And, that's only if clients were lucky enough to have found a mutual fund that performed as well as the S&P 500 Index did during those 48 years.
The "2007 Dalbar Report" tracked investors' behavior in chasing market returns. This report showed that over a 20-year period (1987-2006), the average investor only earned 4.3 percent during a period where the S&P 500 yielded 11.8 percent. And remember, that was during one of the best times in stock market history! What's more, it doesn't include the recent stock market downturn of 2008.
So, if your client had purchased a $250,000, 20-year term policy, at $760 per year and then invested the difference of $5,240 annually into a 401(k) (with no matching contribution) or IRA, with an average annual return of 4.3 percent (per the "Dalbar Report") during those 20 years (1987-2006), he would have had $167,909. And, all of the income he'd take would be taxable. If he were to withdraw $8,395 per year, based on a 33 percent state and federal income tax bracket he would get only $5,625 to spend.
On the other hand...
However, if your client had purchased a good $250,000 traditional universal life or whole life policy back at that time, and then invested the entire $6,000 a year into a policy earning 6 percent, he'd have $166,059. Even though your client will have slightly less money, he could take $8,303 of income each year... income-tax free. That's about 68 percent more money for your client to spend!
And, if he could have purchased a $250,000 index universal life policy back then, and had invested the entire $6,000 each year into the policy at a rate of 7.55 percent, he would have $208,608. Your client could take $10,430 of income each year, income-tax free. That's almost double the amount of spendable income he would have if he had chose to invest in a 401(k) or IRA.
Just based on the numbers, it appears that cash value life insurance can make a lot of sense for most people. And, that doesn't consider the many other unique advantages of cash value life insurance:
- Unlike qualified plans, there are no caps (limits) on how much money you can save each year. You are only limited by the size of the policy.
- Your cash values accumulate tax deferred.
- You have a liquid "emergency fund" for life's unexpected events.
- The cash values can be accessed income-tax free and penalty free prior to age 59½.
- Cash value life insurance is not attachable by creditors.
- Cash value life insurance doesn't count as an asset when you apply for college financial aid.
- By overfunding a cash value life insurance policy up to the MEC guidelines, it can become "investment-grade life insurance." (Missed Fortune concept)
- The cash accumulated in the policy can provide a tax-free income in retirement. (Taking withdrawals up to the cost basis and then borrowing the remainder)
- You'll have the protection of life insurance in your retirement years to replace lost pension and Social Security income at your death. (Pension Max concept)
- Unlike qualified plans and annuities, the death benefits and cash values are transferred income-tax free to your beneficiaries.
- Cash value life insurance generally bypasses probate. (And it is private, no public records.)
- Cash value life insurance can be used to pay income taxes on qualified plans and your estate taxes at your death.
- Safety: All 50 states have something similar to FDIC for life insurance policies and annuities. Plus, insurance companies must, by law, cover at least 100 percent of their liabilities with reserves, hence the term "100% legal reserve life insurance company." There are also regulations as to the percentage that can be held in certain forms of assets. his system has produced a remarkable overall record of solvency and safety.
- Guarantees: Only life insurance and annuities guarantee your investment principal and offer you minimum growth guarantees for the life of the contract.
© 2008 Lew Nason, RFC, LUTC Graduate - All rights reserved
*To discover more about what Lew Nason has learned in his 30 years' experience and his "Found Money Management" program, please use the forum below and include "FMM" in the subject line.