Let me guess, was your first thought, “are you serious?” If so, don’t worry mine was too. How could life insurance be like anything like a Roth?
When I was first presented with the idea that life insurance was more than purchasing protection about five years ago, being a CFP®, I immediately thought the same thing, this can’t be right. I mean outside of a few cases like when individuals have a high need for income protection being the primary breadwinner of the family, paying estate taxes, paying off debt and future obligations with a death benefit, or using it as a gifting strategy to avoid the estate tax exclusion (for the ultra-wealthy), I didn’t think there was more. I knew a lot of people needed it but I just thought most people would get term life insurance and call it good.
It wasn’t until I spoke with a CPA and one of the leading tax attorneys in the country on multiple zoom calls, thanks Covid, where everything I thought about life insurance was flipped upside down. I think many people were and maybe still are in the same position as I once was years ago. I am here now to tell you that permanent life insurance might be one of the best-kept secrets that the ultra-wealthy have been using for decades to get tax-free income, leverage, income protection, and asset protection.
Now there are a million ways to design life insurance but I want to share with you on a high level how some of the policies we design work and why it might be something that would complement the rest of your portfolio. As a financial planner, I want my clients to have a wide variety of different income streams, strategies, and ways to grow their wealth. Life insurance, I believe, was the piece I have been missing in our InSight-Full® Plan. My goal for every client is to help them reach their goals by maximizing how each dollar is used both now and in the future by simplifying each part of their financial lives. This means finding which accounts should be funded, when, how, and then how to withdraw from them when you need them.
So why is life insurance so great? For the right person and situation, some types of permanent life insurance policies can provide individuals a mix of growth, protection, tax-free income, and additional leverage should they choose to use it.
Let’s start with growth. Whether you’re using a universal life policy that’s tied to an index (think SP500) or ownership in an insurance company (think of a dividend payout) clients can accumulate wealth inside of a policy that’s providing them protection. As the money grows, the death benefit can also increase which means more of a payout to beneficiaries. In some types of insurance like whole life, cash accumulates (cash value) similar to that of a bank account. As that money accumulates, policy owners can withdraw that money and pay interest back to the insurance company. The beautiful part about this is the dividends paid by the insurance company for owning whole life insurance can be more than the interest being charged (leading to a positive arbitrage).
Second, since most individuals use life insurance for asset protection and income protection for a certain amount of time (term insurance), permanent life insurance gives you this protection for life. Unlike term insurance, where once you reach the end of your term your coverage ends and there is no value remaining, permanent life insurance continues giving you the flexibility to use the cash value accumulated for almost anything you want. So whether you take out a loan and use that money to make other investments or you annuitize your cash value into an income stream, having permanent life insurance can provide you more value in my opinion than term insurance in the long run due to its cash value.
Permanent life insurance can be used as a tax-free income generator as well. Every premium that is paid earns dividends and interest. As that money grows and compounds over time, you end up with a nest egg of cash value. This cash value can be annuitized into a tax-free income stream for life (all growth inside the policy is tax-free) with distribution rates as high as 6-7%. Outside of a Roth IRA and Municipal Bonds, tax-free income is hard to come by. Tax-free income that also pays out a death benefit to beneficiaries is a win-win for everyone.
Lastly, some insurance companies allow life insurance to be used as collateral for a loan making permanent life insurance one of the most flexible and lucrative vehicles out there.
So whether you’re looking for income and or asset protection, tax-free income in retirement, leverage, or coverage for estate taxes, permanent life insurance is a great place to look. Keep in mind, not all insurance policies are created equal and provide the same features so you need to make sure to do your due diligence, talk with a professional, to make the best decision for you and your family.