For decades, many financial experts have had a standard line on life insurance: “Buy term and invest the rest.”
According to this thinking, a low-cost, bare-bones term policy offering a death benefit but no investment return was the best way to protect loved ones. And the money saved could go into stocks, bonds, or mutual funds that would be easier to manage than the investment component of a complex and costly “cash-value” life policy.
But various types of cash-value policies have always had admirers, and occasionally a buy term believer has a change of heart.
“When I started my career as a financial strategist in 1974, I was a buy-term-invest-the-difference proponent — that is, until 1980 when E.F. Hutton introduced a new take on universal life insurance,” says financial advisor Doug Andrew, founder of Live Abundant and author of “Last Chance Millionaire.”
“Over the past 40 years, I’ve helped thousands of Americans benefit from what is now known as indexed universal life,” he says. “It’s like ‘buy term and invest the difference’ on steroids.”
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Investments in cash-value policies grow tax-free, and withdrawals in retirement are untaxed if taken as loans against the policy’s cash value, he says, warning that careful shopping is necessary to avoid giving up too much investment return to fees.
“Do you have to repay the loans? No,” Andrew says. “The insurance company will apply any loans against the tax-free death benefit upon your passing. Or, you can choose to repay the loan, and your repayments become newly protected principal that can go on to accumulate tax-deferred interest.”
Term policies offer a set death benefit for a given period, such as 10 or 20 years. They are inexpensive, but if you live past the term the policy expires and you have nothing. Various types of “permanent” policies have much larger premiums but build up value that can be used to pay premiums in the future, to borrow against or to withdraw.
Term works well for those who need coverage for a set period — until the kids are grown or other investments are expected to be large enough for needs like retirement. Permanent policies suit those who need a death benefit for life rather than a limited period, and who want an investment that may offer protection against loss.
Indexed universal life policies holding stock funds typically offer a guarantee against loss or a small minimum return, and in exchange cap annual gains at somewhere around 10 percent.
Policies with investment components can be a valuable source of funds when a downturn makes it unwise to tap other investments, says Samuel R. Price, agent with Assurance Financial Solutions in Birmingham, Alabama.
But using insurance to invest for the long-term can have drawbacks. Comparison shopping can be tricky because two policies are rarely the same, and it may be hard to gauge a policy’s track record next to a standard benchmark, the way stock market investors use guides like the Standard & Poor’s 500 index. Also, life insurance fees can be high and hard to see clearly.
Investing within a life insurance policy may involve locking into a strategy that’s hard to change without incurring penalties. You can’t just go online and switch from stocks to bonds with a few mouse clicks, and these products generally don’t have the broad array of options you would in an ordinary taxable account, or even a 401(k).
For these reasons, it’s rare to find an expert who would recommend life insurance as the main investment for retirement or other major goal. But many do say a good policy can work well as a piece of a broader plan.
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A key question: how do you manage the policy once you have it?
Brandon R. Redman, managing partner at Securian Advisors Northwest in Seattle, says he often recommends clients add a cash value policy if they want to save on top of what they are already doing in 401(k)s, individual retirement accounts and similar accounts.
Redman recommends term life to those whose chief need is a death benefit, but says many don’t invest the remainder.
“While buying term and investing the difference sounds nice in theory — and in reality, when you do the calculations — most often it turns into buying term and enjoying the difference,” he says. “Human behavior can be destructive in this strategy.”
In addition to studying fees and annual caps on gains, investors should keep some other insurance features in mind:
First, how easily and how often can you change the investments? Will you be able to easily shift to a more conservative allocation of stocks and bonds after retiring?
Experts say these policies commonly allow reallocations once a year.
“In the best policies there is a significant amount of flexibility,” Redman says. “If your policy severely limits how frequently you can change your investments, I’d stray away.”
Cash value life insurance “with the closest thing to true investment components” is called variable universal life insurance, in which the policy owner can select sub-accounts that behave like mutual funds, Redman says.
Whole life policies offer little or no investment control, he says.
Even with a variable universal life policy, it’s important to determine that the investment choices are broad enough to cover asset allocation changes you might want later, Redman says.
“I also look for automated rebalancing features, and dollar-cost-averaging features,” he adds. “If the plan is to take cash value out, it’s important to also look at favorable policy loan features.”
As with all financial products, shopping around is important. But this is especially important for insurance because there are so many features to consider. A policy may offer add-ons, for a fee, to cover serious health issues, for instance.
“Work with a broker who represents numerous companies,” Price says, urging shoppers to look for the conservative return illustrations — 5 to 6 percent rather than the 7 or 8 percent common in the past.
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“Each insurance company positions their policy for a specific niche in the market,” he says. “Some are good at creating (a larger) death benefit. Some are better at accumulating cash, and still others are geared to disperse cash back to the policy holder.”
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How to Manage Life Insurance as an Investment originally appeared on usnews.com
