When investors seek financial instruments that promise both a specified rate of return and no loss of principal they are looking for “accumulation insurance.” They want financial certainty, and will forgo alternatives that present potentially higher, non-guaranteed returns. While the usual suspects for the guaranteed portion of a portfolio are certificates of deposit and high-quality bonds, cash value life insurance products should also merit consideration.
Similar to a mutual fund, ownership of a cash value life insurance policy allows an individual to participate fractionally in a larger investment portfolio. The investment portfolios of most life insurance companies are heavily weighted toward high-grade bonds and similar conservative debt investments. A mutual fund holding a comparable portfolio of conservative assets might produce similar returns, but neither the share price nor returns would be guaranteed. In contrast, a standard whole life policy will offer constantly adjusted guarantees for both principal and earnings.
The excess earnings paid to the owner of a cash value life insurance policy are characterized as dividends and expressed as a crediting rate. For whole life versions of cash value life insurance, dividend rates are usually declared annually. The dividend rate reflects not only the performance of the insurance company’s investment portfolio, but also profits realized through favorable mortality experience and lower administrative costs. Because dividends can be affected by issues other than investment performance, the crediting rate for dividends will not always mimic market rates for conservative financial instruments. However, the crediting rate will usually correlate to broader trends; if interest rates go up, the insurance company’s annual crediting rates may rise as well.
While dividends are not guaranteed, highly rated life insurance companies have a long history of paying dividends every year. And once the crediting rate is declared, it applies for the duration of the dividend period. Policy owners can track the dividend histories of their policies, and studies have shown the historical investment performance of life insurance cash values compares favorably with returns from high-quality bond portfolios.
Life insurance policies provide tax-free accumulation; unlike certificates of deposit or bonds held in a non-qualified account, annual cash value dividend distributions are not subject to tax (as income or capital gains) as long as they remain in the cash value account. In later years, the cash values may be configured to provide income, by taking either irregular or systematic withdrawals. Cash values can even be transferred to an annuity to provide guaranteed lifetime payments. Upon distribution, any gains from the cash values will be taxed as regular income, but the amount of tax due will depend on the manner in which funds are withdrawn.
While a typical permanent life insurance policy allows liberal access to cash values as either loans or partial surrenders, some contractual restrictions and tax issues may apply. In addition, a portion of the deposits to the contract (i.e., premiums) must also pay for the insurance benefit. While different policy features and premium formats can significantly increase or decrease cash value accumulations, contract holders must always account for the additional cost (and value) of the life insurance benefit when considering how a cash value insurance policy might fit in their larger financial picture. In order to have the advantages of a cash value account, you must buy a life insurance policy.
Given these parameters, financial experts have, in the past decade or so, begun to consider life insurance cash values as a unique asset class. Richard Weber, a principal with The Ethical Edge consulting firm, and co-author of a 2008 white paper on cash value life insurance, concluded that a combination of life insurance cash value with bonds delivered a higher return with lower risk compared with the all-bond portion of an individual’s portfolio. Adds Weber:
“Investment managers should realize there may be a place for life insurance as part of the fixed income part of a portfolio. Fixed income investments have low correlations to stocks. Life insurance cash values don’t move in the same direction (as stocks or bonds) during a crisis.”
Maximizing the Insured Accumulation Features With Paid-Up Additions
Paid-up additions (PUAs) are small chunks of paid-up insurance attached to an existing whole life policy. PUAs add to both the insurance benefit and cash values. While typically acquired through dividends generated from regular premiums, many policies allow for the purchase of additional PUAs through the payment of unscheduled “extra” premiums. The amount that can be added as a PUA depends on the size and status of the base policy; if extra PUA premiums exceed IRS guidelines, the policy’s tax status may be negatively impacted.
“Life insurance is a complicated, wonderful, frustrating and intriguing asset to understand and acquire.”—Richard Weber.
By Elozor Preil
