When most financial advisors and clients think about investing, life insurance is probably not at the top of the list. Stocks, ETFs, mutual funds and the like are generally the primary portfolio components for most of your clients. This is as it should be.
There are two main types of life insurance. Term life insurance has no cash value or investment component. Term life insurance offers a death benefit over a specified term.
Permanent life insurance has a cash value component. There are a number of cash value options across an array of cash value life insurance types. The cash value grows tax-deferred inside of the policy and can generally be accessed by your clients during their lifetime as a cash withdrawal or as a policy loan if needed.
Some types of permanent life insurance policies have features that can be attractive as an investment vehicle for some of your clients.
Does the Client Need Life Insurance Protection?
The main reason for most people to buy a life insurance policy is for the guaranteed death benefit that will go to their beneficiaries. Life insurance is an easy way to build or increase your client's estate. It can also be a useful tool in your client's estate planning strategy, providing a cash benefit to your client's beneficiaries in the event of their death.
If your client doesn't need the death benefit, then it generally doesn't make sense to purchase life insurance solely for the investment features.
How Cash Value Life Insurance Works
Permanent life insurance policies include an investment component called cash value. A portion of each premium payment adds to the cash value of the policy, with the rest covering the cost of the insurance death benefit.
There are several varieties of cash value life insurance, and the split between the amount of each payment that is allocated to the policy's cash value and the cost of the death benefit will vary by policy type and by the specific insurance company.
The cash value grows tax-deferred inside of the policy. Policy owners can borrow against this cash value. They can also withdraw from the cash value. These withdrawals are generally tax-free, but to the extent the withdrawal amount exceeds the policy's basis, that portion may be taxed.
One important difference between the cash value of a life insurance policy and money inside of an annuity is that there is no penalty for taking a withdrawal prior to age 59.5 as there generally is with an annuity product.
Dividends, on policies that pay them, can be added to the cash value and allowed to grow. Or the dividends can be directed toward paying some or all of the policy's premiums.
It's important to note any amount of the cash value that is withdrawn from the policy or taken as a policy loan will reduce the policy's death benefit.
Cash Value Life Insurance Policies for Investing
Whole life insurance features fixed premiums and a guaranteed death benefit. Cash value within the policy grows at a guaranteed minimum rate, which is typically on the low side. The premium level does not change over time. The premiums on whole life policies are typically pricier than other forms of life insurance.
Universal life insurance is another type of permanent life insurance policy. With universal life there is flexibility with the premiums and the death benefit. The interest rate on the cash value portion is generally in line with current money market rates.
Variable universal life insurance is similar to universal life insurance with the added benefit of offering underlying investment sub-accounts where the cash value of the policy can be invested.
These sub-accounts can go up or down in value like any other investment account.
Indexed universal life insurance is another form of universal life insurance. In this case, the return on the cash value is tied to the performance of an index like the S&P 500. Typically there is a cap on the amount of annual upside of the index the policy owner can earn. There is also usually either a minimum level of interest or a floor on the amount of loss the cash value can incur in a single year.
Variable life insurance is similar to variable universal life except that there is not the ability to adjust the premiums. These polices do offer investment sub-accounts for the cash value.
There are certainly other types of permanent life insurance policies beyond these five varieties.
Benefits of Life Insurance as an Investment Vehicle
Using cash value life insurance as an investment may offer some advantages for some clients.