Life insurance is probably one of the most misunderstood financial tools on the market today. Insurance salespeople have a tendency to overstate its value while glossing over the downsides. But investment jockeys tend to downplay its value in favor of other tools. Reality is somewhere in the middle. It’s a valuable tool, and a necessary one. The more you know about it, the easier it will be to determine how much and what kind are right for you.
As investors, we always aim to grow our wealth for a better and brighter future. In this article, we'll be discussing five surprising things that you probably didn't know about life insurance.
- You can keep your money earning for you, while you spend it.
Well, not quite. But close. You can keep your money earning for you while you spend the insurance company’s money. When you put a whole life insurance policy in place, you can choose to fund it for cash access. When you do this, you reduce commissions and fees, and you increase your rate of return and access to cash. In some of the most aggressively funded policies I have seen you can access 87% of your initial contribution within 30 days of implementation. For year two, you can access as much as 97% of your contribution, and by year three you can access 99% of your contribution. Way more than most people realize because most off the shelf policies are not structured this way..
Once you accumulate cash in the policy you can borrow against it. The insurance company doesn’t care what you use the money for. And they don’t care how or when you pay it back. There is no required monthly payback schedule, no reporting to a credit agency. In fact, you have all the same freedom you would have with a cash account, but with more benefits, and generally a higher rate of return.
All of your money keeps earning and compounding with no interruptions and you can use the insurance company’s money to acquire whatever you need to acquire. The on caveat is that you cannot borrow more than you have in the account. And yes, the insurance company will charge you interest to use their money, but when you borrow and payback, over time you will earn more than you pay the insurance company in interest.
- Your insurance doesn’t have to be a cost item.
You might think of life insurance as an expense, but if you structure it correctly, it can be an asset that has a strong rate of return. By using a strategy known as “max funding,” you can increase the cash value of your policy very quickly. Over time, a whole life insurance policy from a healthy mutual insurance company will typically have a net rate of return of 4-6%. That’s after fees and with tax free access to your cash value.
To get to the same place in an investment account I would need to earn much more. Why? Because the average fees coming out of an investment portfolio range from 1-2% Plus, taxes rage from 20-37%. To end up at 4% after taxes I would have needed to earn 5% on the low end, 6.35% on the high end. Add on fees and that’s 6% on the low end, 8% on the high end.
Earning those return equivalents with no risk of loss is not a bad deal for at least a portion of your portfolio, especially given other benefits like death benefit, or how insurance can impact income rates in retirement.
- An insurance company WILL NOT over-insure you.
Contrary to popular belief, insurance companies are not in the business of over-insuring their clients. They have strict underwriting standards in place to ensure that the amount of insurance you purchase is in line with your income and net worth. In short, an insurance company would not allow you to purchase a $10 million policy if you only earn $50,000 a year…unless your net worth is $10 million.
In his book, What is Life Worth, Kenneth Feinberg, Special Master of the U.S. government's September 11th Victim Compensation Fund, discusses how he came to determine what the US Government would pay to the families who lost a family member in that tragic moment. The process was remarkably similar to the methods used by an insurance company.
Here’s the basics – how much money would you have to have in a lump sum right now to reproduce your income for the remainder of your working lifetime? Oversimplified, if you are in your thirties, the number is 30 times your current income. In your forties it’s 20 times your current income. In your fifties its 10 times your current income. In your sixties its 5 times. OR your net worth at any stage.
The insurance company does not want to over-insure anyone – that’s a bad business model. It incentivizes bad behavior if someone stands to benefit more from your death than from your life.
- You can preserve the ability to buy a permanent policy at your current health rating for 20 years, even if you become uninsurable.
Nobody wants life insurance until they need it. But some of us get it anyway.
Listen, I like to compare myself to fine wine. I believe my personality gets better with age, but I can’t say the same for my health. As a broad generalization, across the population health declines as we get older. That means the longer we wait to buy an insurance policy, the more expensive it will be. Insurance companies look at mortality risk – the likelihood you will die – and use that to determine the price of life insurance. The worse your health, the more expensive the policy.
A permanent insurance policy can be a good idea for many reasons – many of which have nothing to do with legacy, and everything to do with maximizing your income during retirement. However, sometimes it’s not in the cards because it’s not in the budget. Waiting to build a permanent policy can be risky though – what if your health declines and the price sky rockets? Or worse, what if you become uninsurable? Well, if you are insurable now, you can purchase a term policy that offers a conversion option. That option allows you to convert the policy into a permanent policy without having to prove insurability at some point in the future. In other words, you can insure your insurability.
And as a bonus, some companies even allow you to preserve your current health rating for up to 20 years, meaning at any time over that 20 year period, you can turn some or all of that coverage into a permanent policy at your original health rating, regardless of whether the insurance company wants to insure you or not.
- It can replace the bond portion of your portfolio.
Most investors have some exposure to bonds in their portfolio to balance out risk. However, life insurance can also provide a similar role. Whole life insurance policies, in particular, offer a stable and consistent return that can act as a substitute for bonds. And because of how insurance company’s manage inflows of new premium against outflows for paid death benefits, you can minimize exposure to interest rate risk in a way that you cannot accomplish in your own bond portfolio. Plus, an insurance company can access institutional bond offerings that most retail investors don’t have access to. This can help diversify your portfolio while providing you with a tax-free income stream in retirement.
While life insurance should not be the only tool in your financial belt, it is an important one. Like any tool, it is only as effective as the person who wields it. Understanding how it fits into your bigger strategy is key to acquiring the right type, and building the right funding strategy.
