Keeping Your Financial Advisor Honest #3: Variable Life as an Investment

Variable Universal Life Insurance Plans:  A tax deferred blessing, or a risky time bomb?

( The purpose of this article is obvious: I am seeing a trend recently from marketing agencies and financial advisors recommending indexed or variable universal life insurance policies where they not suitable.)

Question:  " I have a permanent life insurance need and my insurance agent recommended a Variable Universal to me stressing the following advantages: Income tax deferral growth, and tax free loans?  What is the catch?  Should I consider this in lieu of an IRA account or other long term investments? "

The answer: This may not be the best alternative for you as an investment vehicle due to internal fees and mortality charges; even though permanent life insurance still has value as a cornerstone of any financial portfolio.

Negatives to consider:  What you may not know about policy loans: 

1.) If you need to take tax free policy loans  they reduce your beneficiaries death benefit proportionately. Every loan not repaid reduces the life insurance.

2.) The interest on policy loans is reasonable; but it compounds yearly until repaid and reduces the cash value available for retirement income. It is not repaid if your goal is income.

3.) If your policy investment sub accounts do not perform as expected or the insurance company raises the internal cost for the insurance benefit  (They can do that) ; you can run out of cash values and be faced with a SERIOUS dilemma:  income taxes on the prior loans (Those used for income and not paid back)  will be due immediately in the year that the policy lapses.

What you may not have been told about expenses and fees:

Before you can realize a net gain in any given year you must first earn enough interest to cover yearly fees and the basic cost of the insurance inside the policy. This can easily be from 3% to 5%. in addition to the insurance cost. When you factor in that the cost of the insurance can be raised; your premium and cash values cannot be projected accurately.  F.I.N.R.A,  the police dog for these types of policies,  requires that the agents and companies show how the policy will perform at both current, midpoint, and zero percent rates. 

What are other options if I still plan to keep my life insurance for a lifetime?

First of all, An objective advisor will be looking at your entire financial picture based on your goals; in order to determine whether you need a permanent or temporary life insurance solution. 

Permanent Life insurance with guaranteed level premiums.

1.) No lapse universal life:  These plans are low cost permanent solutions; stripped of their cash values for the most part but feature: Guaranteed level premiums and guaranteed level insurance for up to your age of 120; should you live that long.  These are very suitable in most cases; but not designed to build cash values.

2.) Traditional Whole Life Policies. The premiums and insurance are guaranteed to be level for life with dividends being credited to the policy in years when the insurance company declares them.  They have safe guards that universal life plans do not offer but require very high minimum premiums.

3.)  Indexed Universal Life Plans: You have a potential for tax deferred growth based on index choices such as the S&P 500; but as with all universal  life plans; the internal basic life insurance cost can be raised in the future; which would reduced your yields  proportionately. They have some internal safeguards and flexibility within; but have several moving parts; so a consultations with an advisor is needed.

In summary,  There is no type of life insurance that is best for all.  Please see my Jan. 4, 2011 blog entry for a layman's summary of different insurance types. If you need  life insurance for permanent needs and not as a temporary solution; consider the fact that the computer projections for life insurance cash  are based on history which is no guarantee of future performance. Also consider that fees in most permanent life insurance are higher than other investments which might be suitable for you.  Permanent life insurance often makes more sense than a temporary 10 or 20 year, plain vanilla, level term insurance policy; but you are best advised to consider a guaranteed, no lapse universal life plan for permanent needs unless you have a clear need for additional tax deferral in addition to your other savings vehicles.

I also recommend that regardless of the plan chosen you ask for a comparison spreadsheet of the top 5 companies for product performance and also for financial strength ratings. Demand a vital signs report which would be free.

I have advised both consumers and financial advisors for over 27 years. Feel free to contact me directly for more information. This is not offered as direct investment advice. Please contact your CPA, attorney, or other professionals for advice regarding your specific situation.

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