Whole life insurance has many unique features and can be a very important part of an individual’s financial plan. Term life insurance may be less expensive for a short-term death benefit need, but permanent whole life insurance is usually a much better and less-expensive option for anyone with a longer time horizon. Many times, people feel that they will never have a need for life insurance after 20 or 30 years, but there may be a number of reasons to continue to have this coverage in place.
The income an individual is earning at the time of death may need to be replaced almost immediately and many assets a couple may have are not liquid and are unable to be sold and converted to cash at the time when cash is needed most to meet current expenses. An illness of one’s spouse may seriously deplete savings before they pass away, leaving the surviving spouse in a precarious financial position – one much more difficult than either spouse ever imagined. Social Security and pension payments may end or be reduced at the death of one spouse. There may be expenses and commitments to adult children, grandchildren, charities or second mortgages. The death benefit from a life insurance policy can help with these issues. Estate taxes can claim 50 percent or more of someone’s assets – money that goes to Uncle Sam rather than the children and grandchildren that you had planned for. Whole life insurance can be an important tool for estate planning. It provides an influx of cash; usually income tax-free, just at the time the estate tax bill comes due.
Whole life insurance, unlike term insurance, provides living benefits as well as death benefits. This article will focus on one of these living benefits – using the cash value component of your whole life insurance policy as the fixed income piece of your overall investment portfolio.
Many whole life insurance policies accumulate a cash value which, over time, can be a very useful part of one’s investment portfolio. In simple terms, when you pay your premiums for your whole life policy a portion of the money covers the death benefit and a portion is invested in the cash value account. This cash value account grows, tax-deferred and withdrawals and/or loans from the policy generally are received tax-free. The insured can use this money for any reason and, provided there is sufficient cash in the account, can be taken out at any time. One possible advantage of having this accessible amount of cash is that you do not have to worry about liquidity issues as you do with equities – incurring capital gains, selling at the wrong time (i.e., when the market is down) or other tax issues.
When comparing the rate of return of whole life insurance with other financial products it is important to compare them to other fixed income vehicles such as CDs, money market funds and bonds. They are the most common vehicles people use for their “safe” money. These vehicles and cash value or whole life insurance are considered safe assets in an overall financial portfolio. Equities usually have a much greater potential for a high rate of return but also have the potential for greater loss. So when considering the adage “Buy term insurance and invest the difference,” it is crucial to understand that different types of financial products each have their own risks and advantages. Any properly diversified portfolio will have some of the assets invested in equities and some of the assets invested in fixed income. The fixed income piece of your portfolio that is for the long term can be found in the cash value of your whole life insurance. Not only is the rate of return favorable but you also have access to the cash as you need it. Withdrawals will usually be tax-free and you will not incur any capital gains.
As a hypothetical example, let’s look at an actual whole life insurance policy belonging to one of our firm’s clients, purchased 25 years ago by a then 45-year-old male non-smoker with an initial death benefit of $250,000 and an initial premium of $5,772.50 per year. The policy, at the end of 25 years, has a cash value accumulation of $272,138. The death benefit has also grown to a value of $470,743. The total premiums were $144,312.50. The internal rate of return on the cash value in the policy has been 4.58 percent. In order to earn 4.58 percent in a taxable account in Maryland, an individual in a 33 percent tax bracket would have to earn over 7 percent. As you may know, it would be very unusual to see a 7 percent rate of return offered on a CD or for a money market account. Long-term bonds may potentially offer comparable rates at certain times but in many instances may be callable. Of course, the actual rates of return of the cash value in a whole life policy are based on the dividend history of the insurance carrier and will vary over time, which is why you must pay careful attention to the financial strength and dividend history of the insurance carrier you choose.
As you look to the future for your financial planning be sure to consider all the advantages of permanent whole life insurance – both for the death benefits and the living benefits.
Kelby Gelston, CLTC, is with FranklinMorris, Coordinating Broker for the Bar Associations Insurance Agency, Inc. For more information on insurance benefits available to MSBA members, visit our website at: www.msba.org/departments/membership/baia/franklinmorris.pdf.
Gary C. Norman is the 2008 recipient of the Edward F. Shea, Jr., Award, Chair-Elect of the MSBA Animal Law Section, and a frequent writer and speaker on disability law and policy.