Is Life Insurance a Good Investment?

Did you know that September is Life Insurance Awareness Month. I would be remiss if I had nothing to add.

I had a discussion with someone recently who asked if I thought life insurance was a good investment and my answer came quick and easy. No, no way, no how. Life insurance is for death benefits, it is NOT an investment.

If you are looking to accumulate cash, there are better ways. Like every other service, insurance has a cost component. It would be tough to find a life insurance product which can consistently out perform an investment of equivalent risk which does not have to cover the cost of insurance. "But life insurance cash values accumulate income tax free" argue the proponents. They argue that the tax benefits offset the cost of insurance. Baloney. There are other ways to invest tax efficiently that come far cheaper than insurance.

Yes, I know that properly structured low cost loans can be used to get cash out of a life insurance policy without ever paying income tax on it. Most of the policy owners who are using those techniques do not understand the associated risks, and the risks are huge. These loans avoid taxation because the loan is ultimately repaid out of the tax free death benefit. But if the policy were to underperform (that is, earnings within the contract do not grow fast enough to service the interest on the loan), the policy would lapse and the loan would be repaid using the contacts cash values. While that seems harmless enough, in the eyes of the IRS the life insurance loan was forgiven and the forgiveness of a loan is taxable as income! Worse yet this loan may be forgiven years and years after the money was spent.

Imagine a man 65 years old who has accumulated a nice chunk of change in his life insurance policy. His insurance agent shows him that he can borrow $25,000 a year for the next 10 years from his policy and avoid paying income tax on the income. So he borrows the $250,000 from age 65-75 and lets the interest accumulate on the loan. Now at age 90, the outstanding loan has grown quite a bit. Let's call it around $650,000. If the loan amount is essentially the same as the insurance policy's cash value, the policy lapses and the loan is forgiven. Now this 90 year old man must either repay enough of the loan to keep the policy from lapsing or pay income tax on $650,000! Either option is going to require significant expense. Mind you, the last of the $250,000 was spent 15 years ago. A qualified competent professional can prevent this from happening, but who is that going to be? If you are 35 years old now, I can not promise to be here for you when you are 90.

There is a role for permanent life insurance. It is just not an investment.

new briefcase photo by dcJohn

Comments

[David Lewis]

Many people do mistake life insurance as an investment. I think it's easier for agents to say the cash value portion of permanent insurance resembles an investment.

But, there are many cases where permanent insurance makes sense, I agree. As for overloaning...we should make sure that we are getting overloan protection riders on the policies if they intend to do heavy borrowing in their later years, right?

[Art Dinkin]

David, I agree. If someone is counting on using policy loans in later years to take out cash values, a rider protecting the contract from lapse via loans would make sense. Problem with those riders though, is that they do not allow access to all the cash value. While they are a good saftey net in case of an unexpected need to access the values. In my opinion, if the goal is to accumulate value, better options exist.