Can life insurance be used as a fixed income investment?


Q. I am 55 years old, recently finished a four-year battle with cancer, and will be retiring soon. I have a healthy portfolio, consisting of 60% in blue-chip stocks and 40% in fixed income, which will look after my husband’s and my financial needs in the future.  I also hold a $2-million life insurance policy that I pay approximately $15,000 per year for. 

I am considering switching the policy to a guaranteed payout upon my death, but that would put the annual premiums up to around $35,000 per year. Because I hold 40% of a large portfolio in fixed income, I’m thinking this would be a better alternative as the rate of return from my insurance policy would be much higher than I could achieve in fixed income. 

Curious if you have had clients in the past whom this made sense for. I know my advisor will earn a lot on this policy, and I wanted to get your Coles notes on whether this would or could be something to consider.
–Dana

A. Congratulations on beating cancer, Dana. You refer to your battle in the past tense, so I assume that means you’re in remission now. 

Life insurance should generally be used to protect dependents from the risk of a breadwinner dying, so that a death benefit payout can replace their future income. Towards the end of someone’s career, life insurance may no longer be necessary from a risk management perspective, given that future income disappears at retirement. 

However, there may be tax strategies involving life insurance to consider, and there may also be potential charitable strategies. 

So, many people can consider cancelling their life insurance late in their careers. One exception may be if their health is poor; in that case, the opportunity to keep a life insurance policy in place may provide a good return on the premium cost for the policyholder’s beneficiaries, even if the coverage is no longer needed for income replacement. 

Studies show that people who have survived cancer generally have a shorter life expectancy, so I think this is something to consider with your life insurance policy, Dana. 

It sounds as though you are considering converting a term life insurance policy to a whole life insurance policy. A term life insurance policy has premiums that are the same every year for a certain number of years, and that increase at renewal. Common examples include 5-, 10-, or 20-year term policies. So, the cost steps up at each renewal, over time. 

Many term policies can be converted to whole life policies that have the same premium payable every year thereafter for life. The conversion option may only be available up to a certain age—like 75, for example. The whole life premium ($35,000 in your case) would be higher than a term life premium ($15,000 in your case) in the early years, and lower in the later years. 

A whole life insurance policy generally has a cash value that builds up in the early years because of the additional premiums that exceed the pure cost of insurance in those years. This value can be withdrawn, borrowed against, or allowed to continue to build. 

If someone’s health is poor and their life expectancy is likely to be very short, they may pay less in cumulative premiums by continuing to pay the escalating term life insurance premiums. Regardless, Dana, you should review the policy options in detail with your life insurance agent and be candid about your health problems. 

I often compare liquidity events to fixed income. In other words, if someone is planning to sell or downsize their house, is selling a business, expects an inheritance, or anticipates a life insurance payout, the result of any of these events can be very much like a GIC or bond that matures at some point in the future. Some of these events are more predictable in terms of the timing and amount of incoming cash, and can sometimes justify taking on more risk with an investment portfolio. 

It does not sound like your health is so bad that you expect a really short life expectancy and an imminent life insurance death benefit to be paid out to your husband. On that basis, Dana, I think you need to be careful about considering your life insurance policy as the fixed income portion of your portfolio. You may be able to withdraw from the cash value portion of a whole life insurance policy or borrow against it, but you still need to manage your investments independently from the life insurance. 

If your investments are 80% or 100% in stocks instead of 60%, you will have more volatility as a result. You may not be comfortable with the more extreme ups and downs of your investments in a more aggressive portfolio, and knowing that you have a life insurance policy with a cash value may not appease your anxiety during a market crash. 

Another risk, given this is a strategy you are considering early in retirement, is that by increasing your life insurance premiums by $20,000 per year, you will be spending more and drawing down your investments more aggressively in the initial years of retirement. If this happens to be a bad period for stock markets as well, the combination of higher withdrawals and declining stocks could drastically diminish your portfolio. 

The life insurance death benefit may provide a higher return than the fixed income portion of your portfolio, especially given how low interest rates are right now. But if your goal is to earn a higher return, you could do that by increasing your exposure to risk assets like stocks and reducing your exposure to lower-yielding bonds. 

I think you need to talk to your life insurance agent to fully understand your options for future term life insurance renewals and how the whole life insurance policy works. As well, I think you need to consider how the higher premiums will impact your investment decumulation. I would be surprised if the decision on your life insurance policy could not be deferred, to be considered in a few years when you retire. You will have a better sense at that time as to your assets and income going into retirement, as well as your health and any potential remaining impact from the cancer. 

I hope that helps, Dana. There is not a “yes” or “no” answer here. That is often the case with financial decisions. I wish you good luck, and more importantly, good health. 

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.

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