Hammers & Nails
A Tale of Caution if You Are Considering Using Life Insurance as an Investment
by Steven Higgins
Most tools were created for a specific purpose, and when used for their intended purpose simply make life better. An exception is this stupid pancake flipper I saw on an infomercial. When I “flipped” it, I splattered batter all over the kitchen. I tell you this, it’s no “Perfect Pancake.” I’ve been approached recently by friends, neighbors, and clients about using life insurance as an investment. It seems there is an uptick in the intensity of presentations by insurance agents selling these products. The idea can take several different forms, but the basic concept revolves around taking liquid assets and investing them either in a lump sum “single premium” or systematically over a period of time into a life insurance policy. As you write each check to the insurance company, excess premiums beyond that is necessary to pay for the actual life insurance goes into a “cash value” account. This account grows as you make payments and the company pays dividends or interest on the policy. As the account grows you can take loans from the cash value portion of the policy. Since loans are not taxed, this is equated to “tax free income.” Caution! This may be a time bomb. If something happens down the road and you need more money and are forced to take the remaining cash out of the policy, the entire amount of loans you have taken against the policy are taxed as ordinary income and at your highest tax bracket. When making long-term financial decisions, make permanent decisions only when you absolutely have to. As an “old timey” gangster once said, “I never go into a bar without a back door.”
Tips to Consider when Considering an Insurance Product as an Investment
- Who is selling the product? Licensing matters. There is no law governing the use of titles like advisor, professional, etc. In order to sell life insurance, an individual only needs a state life/health insurance license. Many agents also have a Series 6 & 63 state securities licenses allowing them to sell mutual funds and insurance products that have some mutual fund components. Your advising team should include individuals with licenses like the Series 7, 9, 10, and 24 and Certified Public Account and/or Certified Financial Planner designations.
- Is this simply a product or a well thought out plan? Many insurance policies are sold as unilateral products, not as part of a long term plan or discipline. Your success will depend on a comprehensive plan that embodies your entire financial picture. Ask yourself how a permanent life insurance policy works with your overall plan. If you don’t have a plan, ask a financial planner to help you. It is far better to use products as part of a plan than to build a plan around a product. It is frustrating and expensive to “unwind” these products after they are purchased from the neighbor, church goer, or college buddy that got a new insurance job and called everybody in town.
- What are the costs? Using the correct words and asking the correct questions is crucial. Simply asking “how much do I pay?” won’t cut it. Try this instead: ask your insurance agent “How much THEY get paid?” There is now doubt that insurance policies pay agents the biggest upfront commission in the business. The gross commissions on an annual pay life insurance policy is around 70-100% of the first year premium and 3-8% every year after. Additionally, polices can have significant penalty periods, sometimes 10-20 years, where you can be penalized up to 15% for taking your money out early.
- Is there a professional bias? Is your insurance agent able to use a multitude of options to help you meet your goals? If the agent’s only options are insurance related products, you’re likely getting offered an insurance product, no matter what. When you are a hammer, everything starts to look like a nail. Don’t be somebody’ somebody’s nail.
