Stop buying life insurance as a savings strategy. stop buying it as a tax deferral vehicle for retirement savings. stop spending thousands of dollars a month on life insurance premiums, at least until you read the rest of this column.
Life insurance is not a retirement savings strategy.
why do we buy life insurance?
A person should buy life insurance, generally speaking, for one reason: because there would be a financial impact on their business or family if they died. – jonathan novy, investment advisor at ritholtz wealth
Usually your need for insurance is high early in life, when you have many years of work ahead of you. the need for insurance decreases over time and finally drops to zero sometime before retirement. this insurance need curve lends itself nicely to term life insurance. Term insurance, as its name implies, lasts for a certain term, such as 10, 20 or 30 years. Term insurance is the cheapest option because insurance companies know that many of the policy owners will outlive their term and the insurance company will not have to pay the death benefit. http://www.investmentnews.com/wp-content/uploads/assets /graphics src=”/wp-content/uploads2018/09/ci116910911.jpg”
Enter the life insurance agent. here we have a thoroughbred salesman who is incentivized to sell as many life insurance contracts as he can. he is trained to offer a rebuttal to every objection. Term life insurance is cheap, which means sales commissions are low. No insurance agent can make a living selling term policies alone. So you have a million reasons why you should buy whole life insurance, variable universal life insurance, and other forms of cash value life insurance.
Let’s look under the hood of a permanent life insurance policy. First, there is the underlying cost of insurance. This is similar to the premium you pay for term insurance. while you are young, this cost is low, but as you get older, the price of insurance grows. this is important when accessing your “tax-free retirement savings” later through policy loans.
Even when the policy is “paid up” and you owe no premiums, the cost of the insurance is charged against the policy. this matters if the annual dividend falls below the cost of insurance, and is one of the reasons policies lapse and expire.http://www.investmentnews.com/wp-content/uploads/assets/graphics src= ”/wp-content/uploads2018/09/ci116911911.jpg”
but the cash value grows tax deferred!
This is true, but life insurance is one of the most expensive forms of investing. whole life policies pay dividends in the low to mid single digits. All types of policies add the cost of insurance, selling and administrative expenses, and a host of riders to the total cost. If you’ve ever seen an illustration of a lifetime, you’ve probably noticed that it takes 10 years or more to break even with premiums paid.
variable policies are riskier. The first few years of market returns can make or break a variable policy. If market returns are negative, you may end up paying higher premiums later to keep the same death benefit. what a nightmare.
(more: Critics say regulation hasn’t curbed overly rosy projections for indexed universal life insurance)
but the cash value can be withdrawn tax-free in retirement!
This is partially true. The premiums you paid can be withdrawn tax-free, but to access the growth, you must take out a loan against the policy. now you are paying interest on a loan within the policy at the same time that the cost of insurance increases. This combination can be deadly if the costs exceed the dividends and the cash value available to pay these costs. the policy owner now needs to repay the loan and/or pay additional premiums to keep the policy in force. When you die, the loan balance is subtracted from the death benefit. remind me again why we bought this policy?
Permanent life insurance is expensive. When faced with a budget crisis, such as job loss, health care expenses, or college tuition, life insurance premiums are often the first item to cut. Suddenly, the “forced savings” mechanism that was thought to be useful becomes a burden. that rosy projection of cash value turns to dust.
These are valid reasons to purchase permanent life insurance:
• you have an estate larger than the federal (or state) estate tax exemption and want to provide your heirs with liquidity to pay the tax. • You have dependents who need more than the assets you can inherit from them to survive. • You are looking to move assets out of your taxable estate to your heirs. • your partners want to finance the purchase of your share of a private business after your death.
I may have missed a few, but you’ll notice savings aren’t listed. Whether your goal is to save for college, retirement, or something else, there are less expensive and more flexible ways to do it. just say no to expensive permanent life insurance policies you don’t need.
(learn more: technology is speeding up the process of issuing life insurance policies)
blair duquesnay is an investment advisor at ritholtz wealth management.