life insurance as an asset class

When we think about integrating life insurance into a client’s financial plan we often start with the traditional needs – a family with young children, a client that may face estate taxes, or someone who wishes to pass on a legacy to family or a charity. But the potential role for life insurance can extend into tax planning, estate planning and investment management as well.

In some cases, insurance can function as a unique asset class within your investment portfolio. To be clear, when using this strategy, one must understand they likely will never receive a personal benefit. This is typically used in a legacy portfolio meant for heirs.

As we consider life insurance as a unique asset class, the following overview outlines key benefits offered by permanent life insurance options such as whole and universal life:

An uncorrelated asset to stock and bond markets

Stock and bond markets are different in many ways, but one feature is always present – volatility. Permanent life insurance can play a unique role in reducing the overall risk of an investment portfolio due to the uncorrelated nature of the cash value compared to other types of investments. With a universal or whole policy, your premiums play two roles: to pay for your insurance and fund a savings component known as cash value. The consistent aspects of cash value are that the funds grow tax-deferred, and once you have met pre-determined balance requirements, you can withdraw funds, take loans against it, or use proceeds to purchase a different policy. Keep in mind cash value accumulation should not be the primary driver for purchasing life insurance.

A defined, predictable internal rate of return

Permanent life insurance is a contract, and prior to purchase, a client and advisor can understand the return expectations within the framework of the policy long into the future. The primary purpose of viewing life insurance as an asset class is the internal rate of return to life expectancy. Generally speaking, the premiums paid into the policy versus the death benefit will yield about a 5% rate of return to life expectancy. If you die earlier, the rate of return would be higher. In order to achieve a 5% rate of return in a taxable brokerage account, you would need to earn a higher return after accounting for tax drag. A step further, if you are in an estate tax situation, you would need to earn even more in a brokerage account to account for federal estate taxation. In Universal policies, for instance, the cash value component can be locked into a specified interest rate or tied to a financial index, such as the S&P 500, with predetermined floors and ceilings. Uncertainty always exists within stock and bond markets so having a predictable return within the life insurance allocation can provide peace of mind. You know the premiums to pay each year and you know the death benefit.

Tax benefits

Investments made in a brokerage account often generate taxable income as a portfolio grows, reducing the overall value and return of the portfolio. The cash value component of life insurance generally grows tax-deferred (allowing the funds to accumulate and compound faster) and does not create taxable income unless the policy is surrendered at a cash value gain. Additionally, when owned properly the life insurance death benefit is free from income, inheritance, and estate taxes. If tax benefits were not present, life insurance would be a far less attractive option for traditional purposes let alone being used as an asset class.

Simplified wealth transfer

The benefits of a life insurance policy are paid to beneficiaries directly when the policy holder dies. This avoids the delays and additional costs of benefits having to go through probate.

As a final point, life insurance should never be a set it and forget it strategy. We often see clients who have had life insurance for many years but do not examine their policies frequently, or in some cases, at all once they have purchased them. The life insurance market, like any other consumer product market, evolves over time and new features, benefits, and contract options may be created. We review our client’s policies and examine the market landscape each year to ensure the best policy is in place to support their customized strategy.

If you would like to discuss how you can integrate life insurance into your estate plan, feel free to contact us. We would be happy to review your situation.

Ali Swart, CFP®

Director - Wealth Planning

Hall of