Life Insurance for Accumulation…Not So Fast!

I have not been a proponent of using life insurance as an accumulation vehicle. There are number of insurance agents across the country who believes this is one of the few ways to accumulate assets in a tax efficient manner.  And, I’ve also heard and read the comments about the only reason any one would recommend this type of strategy is to earn a large commission. As with most things, there are some truths to all of these.

With that said, I must confess I am slowly becoming a fan of utilizing life insurance to accumulate assets. But, I must also state the policy has to be structured properly and it should be only a piece of the clients overall investment strategy, and not the only one. In fact, I will also state you should not consider this idea unless you have made maximum contributions into any pre-tax investments you have available (e.g. 401(k) plans).

In addition, you need to ask yourself if you think taxes are going to go up over the long term or down. If you believe that over the long run tax rates will increase this approach makes more sense. If you believe taxes will decrease then this is probably not the appropriate strategy for you.

The problem with funding a life insurance policy for income purposes during retirement is that the policy is often looked at as a life insurance policy, and not investment vehicle. For example, if you have a goal to accumulate $1 million of assets by the time you are 65, assuming you are currently 40 and you can achieve a net after tax investment return of 8%, you would need to put away approximately $11,580 per year or a lump sum of $135,200. Let’s assume after 10-years your annual net after tax investment return has been 5% instead of 8%.

What would you do?

If you were truly committed to your $1 million goal you would contribute more money into the fund. Maybe you would also consider adjusting your net after tax earnings assumption from 8% to a lower amount. For purposes of this post let’s assume our after tax earning assumption stays at 8%. Assuming we are making annual contributions, you would need to increase the contribution from $11,580 in year 11 to $14,536 in order to achieve your goal. Under the lump scenario you would need to make an additional contribution of $71,670.

So why is it people view this type of life insurance funding differently than if they were investing in individual stocks?

The answer is simple. It’s life insurance. Contributions made to a policy are not looked upon as an investment, but rather as a premium. Of course there are mortality charges and expenses in a life insurance contract that do not exist with traditional investments, however if the policy is structure properly then these expenses should be less than the taxes you would otherwise owe on your investments.

With all of this said, I would like to reiterate the success of using life insurance as an investment vehicle, or as many in the business like to refer to it, a supplemental retirement vehicle, it is highly dependent on what life insurance product is used and how the policy is designed. Sorry fellow agents, but this means you’re probably going to have to reduce your commissions a little bit.

Stay tuned for our future post on structuring life insurance for retirement benefits.

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