Life insurance reps have always had a rough gig. After all, no one wants to think about dying, especially during the prime of their life.
There’s another way to think about life insurance that isn’t so morbid. Depending on how you structure your policy, you can use life insurance as a way to accumulate wealth.
Notice that the subject of this newsletter is how to use life insurance for investing, not how to use life insurance as an investment. There is a subtle difference between the two, which makes this topic somewhat controversial.
But before we get into that, it’s important to understand that there are nearly a dozen types of life insurance, but they can be broken down into two main categories:
- Term Life Insurance
- Whole Life Insurance
Term vs. Whole Life Insurance
Most people are familiar with term life insurance, which tends to be the least expensive. It simply provides protection for a predetermined period. If the policyholder dies during the “term,” then the beneficiaries receive payments. Payment options are flexible and can be paid out as a lump sum, an installment, an annuity, or an asset account.
Term life insurance can be a smart option for young families that want peace of mind and protection in the event of something unexpected and catastrophic happening. However, other than providing benefits upon one’s death, there’s nothing more this policy offers.
Whole life insurance, on the other hand, has a “living benefit,” not just a “death benefit.” This means that you can receive benefits while you’re still alive. It’s a type of “permanent” insurance, meaning it’s valid for your entire life (or specified maturity date), as long as the benefits are paid.
The money you put into your life insurance policy every month is distributed between your death benefits account and a “cash value” account. There are distinct benefits to this setup.
- Competitive Returns: The cash account is similar to a personal bank account, but with much higher interest rates, often around 5%. Compare that to what traditional banks give you to hold your money, and you’re already ahead of the game.
- Safe Harbor: The funds in your account are also untouchable, meaning that in most states, they can’t be accessed in litigation or bankruptcy.
- Tax-Deferred Growth and Tax-Free Distribution: This account can also function as a tax shelter. The reason is that you can “borrow” the money in the account and use it for investments, building a business, remodeling your home, etc., and then when you pay the money back, it continues to grow tax-free. The loan repayment terms are also flexible, which is a significant benefit.
- Collateral Opportunities: Because you now have a significant nest egg set aside, you can get loans that you otherwise wouldn’t be eligible for. You can’t use your 401k as collateral, but you can use the funds in your whole life insurance account.
- No Loss Provision: Unlike stocks or mutual funds, which can devalue overnight, the funds in your whole life insurance account are safe.
- Liquidity, Use, and Control: Cash is no longer king, but access to it is. If there is market volatility and the world’s cash gets tied up, you’ll still be able to access this account.
- Death Benefits: In addition to these benefits, a whole life insurance policy still has death benefits. These benefits can also be accessed early if the policyholder becomes chronically or terminally ill.
Despite these benefits, it might be a bit of a stretch to call a life insurance account an investment vehicle. Instead, think of it as a high-interest savings account with fringe benefits that you can also use to invest.
If you’re interested in investing in real estate, for example, you can take a loan against your life insurance policy and use the cash flow from your rental property to pay back the loan. The alternative approach is to sock away cash (or liquidate another investment), buy real estate, and then use the cash flow to save money for another investment property. The advantage of using your life insurance policy is the way that you can accumulate wealth, and you can do it on your own terms.
What to Know Before Investing in Whole Life Insurance
Financial gurus are hotly divided on the topic of whole life insurance as a way to invest. They say it’s not an investment tool, and life insurance salespeople are being misleading by calling it one. Some point out that a 5% interest isn’t all that impressive, especially compared to other opportunities, and they’re right.
Unless you started this account right out of college, the money isn’t going to help much in retirement. Where whole life insurance shines as an investment vehicle is that it allows you to use the fund for leverage. You can take the money in the account and use it for future investing. Whenever you find an opportunity that requires cash, you’ll have a ready-made source of funds waiting for you.
Another tick in the negative column for whole life insurance has to do with avoiding sharks in the investment waters. When you buy life insurance, it pays to be on the lookout for slick salespeople who are only looking after their commissions and not your financial health.
Earlier, we mentioned that 5% is often the rate you can expect to receive when you put your money in a whole life insurance policy. However, there are fees associated with managing your account, and not all firms have the same rates. Before committing to a life insurance company, make sure you know what their management fees. Some companies might charge 100% for the first two to four years, which wipes out any growth opportunity your account could have in the short term.
Bottom Line: A whole life insurance policy isn’t meant to be a get-rich-quick investment strategy. Instead, think of it like a high-interest savings account that comes with a variety of benefits. When your account is structured properly, you can use it for other types of investments like real estate or starting a business.
