Life Insurance As an Investment

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Some life insurance policies may be used for more than their death benefits. These policies build cash value. The cash value earns interest over time and may be used for any purpose. This element transforms the policy into an investment-type policy. But, you should understand how these policies are structured before trying to buy one.

Function

Cash value life insurance that is used as an investment must be structured to encourage significant cash value growth. This is done by reducing the amount of death benefit purchased relative to the premiums being paid. The maximum premium allowed by law should be paid into the policy. For whole life insurance, this involves using a paid up additional insurance rider to add enough premium to the policy that the costs fall as the cash value builds up rapidly in the policy (more rapidly than would otherwise occur). For universal life, the policy should be set to the level death benefit option by the insurer and you should elect "minimum death benefit/maximum cash value" prior to the policy being issued.

Significance

Because high premiums relative to the death benefit are paid, the policy's costs drop as the cash value builds up inside of the policy more rapidly than it is scheduled to. The amount in excess of the base policy premiums is invested and no commissions or administrative fees are charged on this amount. This allows the policy to become incredibly efficient.

Benefit

Life insurance cash values are not taxed. As long as the policy remains in force, you may access the cash value of the policy through withdrawals or policy loans on an income tax-free basis. Tax-free withdrawals are limited to the amount of premium you've paid into the policy. All policy loans are tax-free as long as the policy remains in force.

Consideration

Before buying a policy, you should consider what you want from the policy. Whole life, for example guarantees the cash value and death benefit, but may not earn much interest over time. Universal life insurance cash values may be invested in a fixed interest account or mutual funds which pay a higher rate of return than whole life, but with additional risks associated with the policy. You may lose money in the universal life policy if the insurer raises the internal costs of the policy, since it is common for few or no policy values to be guaranteed. Additionally, your policy may lose money if it is invested in mutual funds.

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References

  • "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, Anandi P. Sahu, Robert A Crane; 2007
  • "Life Insurance"; Kenneth Black, Jr., Harold D. Skipper, Jr.; 1994
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