I believe it’s important to talk with every client we serve about life insurance. This discussion is not designed to sell something to them, though many begin to put up an emotional wall when I raise the subject. My motivation is simply to confirm they have something in place. If at all possible, I want to avoid telling a surviving spouse I never talked about it with their wife, husband, or partner after a funeral.
I think one of the reasons people put up their guard when the topic of life insurance is broached is the way it’s been sold to people. In many ways, I believe it’s being sold improperly. Here are 3 problems life insurance is being sold as a solution to that may, or may not be a good fit for you.
Education Fund: Some insurance agents will propose a life insurance policy whenever a new child or grandchild arrives. The type of policy proposed is usually a whole life policy, and the rationale is twofold:
- The cost of the life policy will be the cheapest in the child’s entire life
- The cash value can be used to help fund college
The truth is, this probably is the cheapest premium for a life policy they’ll ever have, but just because it’s a great price doesn’t mean it’s a great use of your money. As far as college goes, you’re better off setting up a 529 plan or funding it with mutual funds. Sheri and I have 6 grandchildren and the 7th one arrives in July. We’re not giving any of them a life policy!
Build A Bank: A colleague who subscribes to this philosophy presented this approach to me. It centers on overfunding a whole life policy, so if your monthly premium is $100, he advises his clients to “deposit” $300 or more each and every month into the policy. Once it accumulates enough cash value, the policy holder can borrow against it to buy a car, a home, etc.
The money is loaned to the policyholder who can either repay the loan, usually at a lower interest rate than a bank may offer, or have it deducted from the death benefit. In order for this to work, the policyholder must continue to overfund the policy so it builds up enough cash value to fund a viable loan. In order to provide a viable death benefit, the loan should be repaid in addition to continuing to pay or overpay the monthly premium.
Retirement Funding: A different colleague presented this to me last year. The premise is you can create a retirement fund by significantly overfunding a whole life policy. They are advising wealthy clients and high earners to contribute $100,000 or more to a whole life policy on an annual basis. When it’s time to retire, the policyholder can then take out loans from the policy to fund their retirement.
Since the contributions are made to a whole life policy, the policyholder is able to avoid taxes on the loans, as well as estate taxes in transferring the wealth to their heirs because proceeds from a life insurance policy are not taxed. There are several caveats if this is to work:
- The policy must be significantly overfunded if it’s to build a sizable retirement fund
- How much is needed for the estate and heirs must be determined and then accommodated for versus the amount needed for retirement
In each of these scenarios, there is some level of validity. Whole life insurance can be used to create a college education, or provide a personal bank, or even fund a retirement, but it can’t do all three. In addition, two of these strategies rely on overfunding a life policy that may earn 5% or 6% (don’t look at projections, look at actuals for the past 10 and 20 years). These two strategies are really for the top 1% to 2% of all wage earners. For the rest of us, term life and mutual or exchange traded funds will do very nicely.
What do you think? Share your questions, comments, and experiences with me on our Google +, Facebook, or LinkedIn pages. I’d love to hear from you!