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Life Insurance Awareness Month (LIAM) just wrapped up in September. It’s a good time to dispel some common myths around this important financial product.
Myth number one: The death benefit is only for those you leave behind An investor can take the difference between the cash value and the death benefit of a whole life insurance policy and deploy other assets to help generate a greater income stream. If you have $500,000 of cash value in your policy and a death benefit of $1 million, then your delta is $500,000. If you invest $500,000 in a balanced portfolio and withdraw 4% annually, then you generate $20,000 per year. The death benefit of the life insurance policy provides financial protection, so you can take that $500,000 and consider either amortizing it or placing it in an annuity. In an annuity, you could possibly guarantee that income for life no matter how long you live.1 While protecting those who depend on you for financial support is one of the best reasons to have life insurance, knowing that you can have more financial freedom to generate income for yourself and your family while you are living life to the fullest is a major benefit as well.
Myth number two: Whole life insurance doesn't generate a good rate of return
For most policy holders, the whole life insurance premiums versus the eventual death benefit typically reveal a strong rate of return for your family. Many people don't compare life insurance returns to the rates of return from other fixed income instruments. Instead, they compare it to real estate or equities, but those are asset classes that you would reasonably expect to generate a better rate of return because of the additional risk. Life insurance is insulated from market risk since you are guaranteed a death benefit, and the cash value of your policy increases every year as long as your premiums are paid.2 With the whole life policy, you can review the historical rates of return to determine what rate or return have you received while the cash value grows tax deferred.3
Myth number three: The benefit of tax-efficient returns is miniscule
It is not a myth that to withdraw all your cash value tax efficiently, you may need to do it through policy loans.4 However, the cost of policy loans in most instances will be less than the taxes. The policy is tax deferred, meaning you don't pay taxes as the money grows. You can take money from a life insurance policy as a return of your premium up to what you paid in. After that, you can withdraw any money above that, but will owe taxes on it. Therefore, many individuals don't take that money they have to pay tax on, and instead opt for the policy loan. If you are in retirement and have this policy, then many financial advisors would only recommend tapping into the policy’s cash value when the market is down. In other words, you invest your money in the market and could take a year's worth of income if the markets were up that year from your investment accounts. If the markets are down that year, you could take the income from the life insurance policy. Therefore, you typically pay no income tax on that money until you reach the point that you exceed the amount you put in.
If you have to take a policy loan, then you don't even have to pay these loans back. Generally, you can find loans in the 4% range either in the free market or directly from the insurance company. Yes, it will lower the eventual death benefit, but it can provide more income during your life and help prevent you from selling stocks in a down market. For many individuals this offers a powerful financial tool to utilize the tax code to their benefit.
Like any other financial product, whole life has advantages and disadvantages, along with some valuable features. It provides permanent coverage, guaranteed premiums that don't increase, has guaranteed cash values, a guaranteed death benefit, and offers possible dividends.5 Whether whole life insurance is worth it depends on your life situation and goals. It’s important for anyone considering a life insurance policy to speak with a reputable financial professional who will take the time to learn about your unique situation, listen to your concerns, and clearly explain the different insurance options that best fit your needs and your budget.
Mark Connely, CFP® with Wealth Design Group, based in Houston, TX
1Contracts are guaranteed solely by the claims-paying ability and strength of insurance carrier.
2All whole life insurance policy guarantees are subject to the timely payment of all required premiums and the claims paying ability of the issuing insurance company. Policy loans and withdrawals affect the guarantees by reducing the policy’s death benefit and cash values. Some whole life polices do not have cash values in the first two years of the policy and don’t pay a dividend until the policy’s third year. Talk to your financial representative and refer to your individual whole life policy illustration for more information.
3Guardian, its subsidiaries, agents and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation.
4Policy benefits are reduced by any outstanding loan or loan interest and/or withdrawals. Dividends, if any, are affected by policy loans and loan interest. Withdrawals above the cost basis may result in taxable ordinary income. If the policy lapses, or is surrendered, any outstanding loans considered gain in the policy may be subject to ordinary income taxes. If the policy is a Modified Endowment Contract (MEC), loans are treated like withdrawals, but as gain first, subject to ordinary income taxes. If the policy owner is under 59 ½, any taxable withdrawal may also be subject to a 10% federal tax penalty.
5Dividends are not guaranteed. They are declared annually by Guardian’s Board of Directors
Material discussed is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice. This material is intended for general use. By providing this content Park Avenue Securities LLC and your financial representative are not undertaking to provide investment advice or make a recommendation for a specific individual or situation, or to otherwise act in a fiduciary capacity.
Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is a wholly owned subsidiary of Guardian. Rethink Wealth LLC is not an affiliate or subsidiary of PAS or Guardian.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.