Investing in Life Insurance: Is It Right for Your Client? | | Think Advisor

Cash withdrawal flexibility

Cash value life insurance offers more flexibility in receiving cash than IRAs, 401(k)s, or annuities. These retirement accounts generally have penalties for withdrawing money before you turn 59.5. There is no early withdrawal penalty for taking advantage of the cash value of the policy.

policy loan

A policy loan is also an option. Many 401(k) plans have loan features, but these loans must be repaid. The main drawback of life insurance policy loans is that the loan balance reduces the policy’s death benefit. You should also be aware that these loans also accrue interest, increasing the amount you must repay to keep your death benefit in full effect.

tax deferred growth

For clients who have reached their maximum contributions to tax deferred retirement accounts such as IRAs and 401(k)s, whole life insurance may be an alternative. The option to withdraw or borrow against cash value offers a level of flexibility that other investment options may not offer.

Even investments held in taxable accounts can result in capital gains or losses when you sell stocks, ETFs or mutual fund shares. For capital gains, taxes are deducted from the net amount received. Realizing a capital loss permanently reduces the value of the net gains from the sale of your investment.

Life insurance investment for children’s education

There are many options for accumulating college savings. One option is the 529 College Savings Plan. You can also invest from a taxable account.

Using cash value within a whole life insurance policy to invest in college is another option. Cash value within the policy will be tax exempt. If the policy is variable insurance, there is an investment subaccount option available.

When a client’s child is ready for college, the client can withdraw funds from the account or take out a loan against policy. For loans, they can choose to pay it back or proceed with a lower death benefit. If your client dies before their child is in college, the insurance death benefit may go toward the child’s education.

One consideration is the potential impact on university financial aid. In most cases, colleges do not retain ownership of parent cash value policies for their children’s financial aid applications. However, cash obtained from the policy counts against the total assets of the parent company.

Life insurance investment for retirement

Whole life insurance can play a role in a client’s retirement savings and investment efforts. Having access to cash value through withdrawals and loans can be a source of cash as clients approach retirement. Investment options offered within some policies help clients accumulate retirement wealth on a tax deferred basis.

The policy’s death benefit serves as a backup source of cash in the event that a surviving spouse or other beneficiary dies near or at retirement.

Another strategy is to withdraw cash from the policy and leave the reduced death benefit in place or let the policy expire. In the latter case, you will need to work with your client to determine if this creates a tax liability of any kind and, if so, whether this course of action still makes sense.

Cash withdrawn or borrowed from insurance can be used directly to cover retirement costs or invested elsewhere to cover future needs after retirement.

Considerations when using life insurance as an investment

Consider the following when deciding whether life insurance as an investment vehicle makes sense for your client:

  • Do they need a death benefit from insurance? If yes, would a higher death benefit to premium dollar be preferred? If so, a regular policy might be a better choice .
  • If the amount withdrawn exceeds the premium paid, this excess amount may be taxable to the policyholder.
  • Investment options within variable insurance may or may not represent equivalent choices to investment options available outside insurance. If the investment goal is growth, this may not be the client’s best option. These sub-account options can also have relatively high costs.

Some policies may be set up on a single premium basis or may allow the policy owner to expedite the payment of the premium in a shorter period of time than usual. This will help you accumulate higher levels of cash value. If, as determined by the IRS, the policy becomes overfunded, it will be considered a modified endowment policy and may be subject to additional taxes and fees for early cash value withdrawals.

Whether life insurance is a solid investment option for a client varies from client to client.

(Image: David Palmer/ALM)

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