Life insurance is probably the least understood of products in the world of personal finance. Few people, advisors and clients alike admit to understanding them completely and many believe them to be an expense that should only be incurred when the need is obvious.
But there is a reason that the insurance companies continue to prosper. In spite of criticism from the media and from most investment advisors, their products provide true and predictable value with guarantees unavailable in any other financial instrument. In these uniquely uncertain times this fact alone makes them more valuable. Once clients are properly informed and their objectives are defined, insurance products often rise to the level of most prominent choice.
We don’t believe insurance provides a strategy for every situation. But we do understand its role in retirement planning. When included in a well-managed investment portfolio, insurance products reduce volatility and uncertainty and increase predictability, thus reducing financial stress.
Consider this: Many retirees suffer a lower than desired standard of living because of their desire to leave something behind for their children or grandchildren. Yet by including a life insurance policy in their portfolio they can determine in advance precisely the amount they are willing and able to provide as a legacy no matter when that time comes. Once in place, they are then free to invest the remainder of their assets in such a way that will maximize the amount of income they can achieve from the remainder of their assets.
This is only one example of how life insurance can benefit a retiree and his/her family. When we hear such an issue expressed by a client, we know enough to present this as an option to address the need. Only by understanding that this option exists can a person make an informed decision regarding the issue of legacy planning.
Other applications may include:
• Providing capital to maintain or enhance the income of a surviving spouse.
• Providing liquidity to pay estate taxes and other costs without requiring estate assets to be liquidated.
• Providing early access to a death benefit while alive to provide the additional income needed to pay for long-term convalescent care.
• Providing specific tax-free “gifts” to grandchildren for college education or other capital needs as they enter adulthood.
• Creating a tax-efficient plan to save for retirement and receive tax free income.
How does life insurance work
Life insurance purchased at older ages is different than the family protection policies we purchased when younger and raising a family. Then it was about providing significant financial assistance IF you die too soon. Now it is about WHEN you die. That means that every dollar paid into a policy represents an investment in the ultimate benefit. We know what you pay into the policy and we know what will come out. To calculate the rate of return all that is not known is WHEN that will happen.
But typically the legacy available at life expectancy represents a rate of return of about 5% after tax. Should you die before then (or with linked-benefit policies – need long-term care) the financial results of your premium investments become outstanding.
The money you pay into a policy goes into the cash value account and is credited by the company with interest that is typically greater than you would receive if left deposited in a bank or money market account. This interest is then used to cover the cost of providing benefits; the death benefit or long-term care benefit. Any that is left over adds to the balance in the cash value. From a portfolio perspective, this cash value is an asset that remains on your balance sheet and is available at any time for any reason. Depending on how much you move into the cash value from, say, a savings account, you may be able to purchase the insurance benefits with the extra interest the insurance company is paying on that money, making the economic benefit to you and your family much greater.
You may not choose to include insurance in your portfolio. But it should not be because it is too expensive.