Do you currently have a life insurance policy? Did you know that there are policies available that allow you to invest within the “blanket” of your life insurance? It's true – but the real question is, ‘is this a good idea?’
The most common life insurance policy that offers an investment option is known as variable life insurance. Upon your death, this policy will not only pay out the full benefit that is promised to you, but it will also pay out your invested money as well (watch the fine print on this though, I have heard horror stories about the invested money staying with the insurance company).
Since this method of investing is somewhat unconventional, it is best to look for both pros and cons to this option:
The major pro to investing your money within a life insurance policy is the tax shelter it provides. While money that is invested through your broker is subject to steep taxes when you realize your gains, capital that is earned within the blanket of your life insurance is protected from all tax, which is a massive benefit considering that the lowest tax bracket on these gains is 15% (but more often is 25% or more, depending on your total income for the year).
A second pro is your ability to borrow from this investment fund. If you were to put money away into a 401(k) or a Roth IRA, that money would need to stay there until you reached the ripe age of 59 ½ years old. Within the life insurance policy however, you can often borrow up to 90% of your funds without incurring a penalty. Have caution when exercising this option though, because that money does need to go back into the fund within a certain time-frame (often spelled out by the various life insurance policies).
The final advantage is a matter of ease and simplicity. When you invest in the same arena as your life insurance, there are fewer things to keep track of. One less password to remember, and one less complex piece of your estate to figure out. Often times, simple is best.
There is one major con to investing within your life insurance policy: fees. While it is nice to be in the protective blanket of the insurance company, it doesn’t typically come without a price tag. Just like a broker, the insurance company will charge a small percentage as a “management fee”, but unlike the broker, the life insurance fee is often quite a lot higher – somewhere in the realm of 2% instead of the typical 1%. This may not sound like a lot, but over the course of a few decades, this extra percent can amass to hundreds of thousands of dollars.
Getting the tax shelter is great, but if you manage your money well and consider the tax implications of your decisions, you can often come out far ahead of what you would gain by investing in the life insurance policy.
Do you use insurance for investing? Why or why not?