Using Life Insurance as An Investment

When it comes to planning your financial future, there are numerous routes available. Most people are familiar with traditional investments like stocks, bonds, and real estate, but one strategy which is often overlooked is using life insurance as a key part of your saving and investing process.

Life insurance is technically not an investment, but sometimes people think of it as an investment because the right type of policy can provide not only protection for your loved ones, but also serve as a powerful tool for building wealth and securing your financial future.

So, should you use life insurance as an investment? You be the judge. In this post we explore the concept of using life insurance as an investment, with a focus on participating whole life insurance (PWLI).

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Thinking of PWLI as an Investment

When you explore a new investment option, one of the first questions that comes to mind is likely: What is the expected rate of return?

When it comes to participating whole life insurance, you can’t find an annual rate of return because the insurance company guarantees a table of values, which includes year by year cash value and death benefit numbers, based on a specific schedule of premiums, a health rating and the insurance company’s current product offering.

There are guaranteed values on the left side, and non-guaranteed (aka projected) values on the right side of a typical life insurance illustration, but no annual rate of return. 

When you dig deeper into the illustration, or the contract for a whole life insurance policy, you may find a rate of return that is assumed for the purpose of calculating guaranteed values, or a rate of return that is used to help define the current dividend scale, but these rates of return are simply the investment component of the insurance company’s returns before expenses and mortality are factored into the equation.

This means we must work from the values on the illustration. It is possible to figure a rate of return from a life insurance illustration by working backwards from the cash value for a specific year and the premium schedule up to and including the same year. This calculation is an iterative cut/try process that results in an Internal Rate of Return (IRR). 

An IRR in this case, is the net rate of return (after fees and taxes) that you would have to earn every single year on an investment schedule matching premiums paid, in order to arrive at the cash value for the policy year in question. The same process can also be used to calculate an IRR for the death benefit values on a life insurance policy.

A whole life insurance policy designed for high cash value and minimal long-term insurance cost will usually have an IRR of about 1-2%/year based on guaranteed cash values during a 20-30yr time frame. 

The IRR on non-guaranteed/projected cash values will often be in the 3-4% range for a similar time frame, but this is based on the profits of the insurance company and can easily be higher or lower than projected over a long period of time.

Obviously, there are investments that can potentially generate higher returns than these figures, but this does not mean you should skip the steady returns and the permanent life insurance coverage that come with a good whole life insurance policy. It is important to note that investment returns higher than this are not often consistent.

Due to these facts, many people like to think of their life insurance as an investment and count the cash values as a part of their investment portfolio, similar to bonds and/or cash in their overall asset allocation. Bonds can provide a steady return over time but can also be subject to interest rates and volatility if you need to sell them before maturity. Cash value growth in a participating whole life insurance policy is steady and guaranteed even when you need access via policy loans along the way.

Using Your Life Insurance Policy as an Investment

Life insurance can be more than just a safety net; it can also be a valuable financial resource. Over time, as you contribute to your policy, you accumulate the option to borrow against the savings you’ve built up. Additionally, your earnings grow on a tax-deferred basis. Here are some ways to leverage the financial potential of your life insurance.

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Borrow from your policy

With permanent life insurance, you have the option to take a loan against its cash value. It’s important to understand the terms of this loan, including the interest rate, which may be fixed or variable and is determined by the insurance provider. Be aware that if the loan isn’t repaid by the time of your passing, any remaining debt will be deducted from what your beneficiaries receive.

Use your policy as loan collateral

In certain circumstances, your life insurance policy can act as collateral for a loan. This could potentially make it easier to secure a loan or negotiate better loan terms. It’s important to remember that if you pass away before the loan is repaid, the owed amount will be deducted from the benefits your heirs receive.

Withdraw funds directly

Instead of taking out a loan, you can opt to directly withdraw funds from your policy. However, if your withdrawal dips into your investment gains, tax implications may arise. Also, any amount withdrawn reduces the policy’s value and, consequently, the payout to beneficiaries upon your death.

Access “accelerated” benefits

Some policies offer the option to access benefits early in the event of a severe medical crisis, such as cancer or heart attack. These policies often allow withdrawals ranging from 25% to 100% of the policy’s value.

Surrender the policy for cash

Surrendering your policy is essentially canceling your coverage in exchange for its cash value, minus any fees charged by the insurer. These fees can sometimes be substantial, akin to early withdrawal penalties from a retirement account. However, if your financial priorities shift and maintaining the policy is no longer feasible, surrendering it can be a practical choice.

Benefits of PWLI

Participating whole life insurance (PWLI) provides several benefits that can make it attractive from an investing perspective. Here are a few:

• Permanent Guaranteed Death Benefit: With participating whole life insurance, your beneficiaries will receive a permanent guaranteed death benefit, ensuring their financial security in the event of your passing.
  
  Many financial gurus say you won’t need a life insurance death benefit forever and should buy term life insurance instead, but this is not always true. A permanent death benefit can often be repurposed to another strategy if it is not “needed”.
  
  Over a long period of time the net cost of a good whole life insurance policy is less than the cost of buying term insurance. Sometimes it does make sense to combine permanent and term life insurance to get the overall protection you need.
• Cash Value Accumulation: One of the most appealing features of participating whole life insurance is the way a policy accumulates cash value over time. This cash value grows tax-deferred and can be accessed via policy loan during your lifetime without triggering income taxes. Cash value accumulation is one of the main reasons people think of life insurance as an investment.
• Dividends: Participating whole life insurance policies offer the potential to earn dividends. These whole life policy dividends represent a portion of the insurance company’s profits and are not immediately taxed (unless you opt to receive them in cash) because they are classified as a “return of premium”.
• Volatility Buffer: While the financial markets go up and down as a rollercoaster, whole life insurance cash values are guaranteed to remain steady and growing. This is another key reason people may think of their life insurance as an investment.