ECONOMICS, NOT EMOTION SHOULD DICTATE IT’S PURCHASE

Two years ago, I remember a $1 million dollar life insurance policy on a 78 year-old wheel chair bound lady who had suffered a stroke with severe heart problems and emphysema was cancelled. The children who ran multimillion dollar businesses and who were paying the premium as part of a buy-sell arrangement decided that it was not worth-while to continue paying the premium of $ 34,000 a year. In the process they lost the premium of $ 150,000 they had already paid as well as the potential death benefit. The agent had made some very sensible suggestions to no avail-paying enough premiums to keep the policy in force. Continuing to pay for the policy would have returned at least 3-4 % on their money. Decisions regarding life insurance are particularly made on the basis of ‘emotion’ rather than ‘economics’.

Why has life insurance received such a bad rap even though it is such a strong economic tool for a business’s or family’s economic health? There are obviously many reasons, uppermost being the ‘sales’ tactics of both the insurance companies and insurance agents. Add to that the fact the acquisition costs and charges for ‘permanent whole life ’policies are incurred in the first few years of the policy. It makes no sense to surrender the policy or do any exchanges for many years after its purchase. Therefore, any ‘permanent’ life insurance policy purchased should be viewed as a long term investment. Another major reason why consumers do not ‘love’ insurance is the products are complex with many moving parts and are difficult to explain as well as to understand.

Having said the above, one needs to evaluate any life insurance policy purely from an economic perspective. As an estate transfer tool, one cannot deny the power of the insurance lobby. In most but not all circumstances, life insurance proceeds are income tax free and if purchased through a properly designed irrevocable trust also estate tax free. Let us then estimate the ‘return’ on investment , return being measured by the death benefit and see if it makes sense. I made an analysis for individuals buying a permanent no-lapse guaranteed death benefit policies at different ages. As an example using one insurer’s software, for a 50 year-old male , with the death benefit of $ 1million and annual premiums paid for 15 years at standard rates, the guaranteed return was 5660 % if death occurred in year one, 10.17 % if death occurred at age 75 and 3.57 % if death occurred at age 95. This would be income tax free and perhaps even estate tax free if the policy was owned by properly designed trust. (Guarantees are based on the claims paying ability of the particular insurer). An analysis of the numbers at ages 60, 70 or 80 would probably turn up similarly attractive results. It would look even better for death benefits being paid at second death (last to die joint survivor policies). In today’s economic environment, the returns look pretty good!

Therefore in estate planning and transfer situations, clearly it makes sense to consider the purchase of permanent joint survivor life policies (single life, if one is uninsurable) policies. Another estate transfer situation, is one where some IRA assets of one’s portfolio is allocated to go to one’s beneficiaries- children or grandchildren and are not to be used during one’s life time. It may make sense to convert taxable IRA assets (taxes are due on IRA withdrawals) to income tax free assets for the beneficiaries by using the leverage of income tax-free life insurance . It is surprising that many wealthy people are not using life insurance as an effective income and estate tax free transfer tool? Emotion probably overtakes reason.

Another scenario, where permanent policies make sense is for ‘retirement planning’. On the assumption that the tax rates will rise in the future and the rate of return on the savings part of the policy –the cash values- would earn a fixed return over the long haul, one can see the benefits of a permanent life insurance policy. For individuals in high tax brackets and ‘lawsuit prone’ profession or business, with maxed out 401k contributions, a permanent life insurance policy might be an additional tool to consider. Remember also that in Texas, both the death benefit and the cash values of a life insurance policy are protected from creditors!

A third example of the need for life insurance is the family support situation- an income replacement scenario. The need may exist for as little as 1 year to as long as 15 or 20 years, In this example clearly a ‘term’ policy preferably a specific term of years with guaranteed level premiums may be the best option to consider.

So in buying insurance, first question ponder what do you want accomplish with insurance-is for estate planning transfer, supplement a retirement plan or is it as an income replacement tool (family support) how much can one afford. The answers will determine type policy to be purchased. Lastly, let ‘economics’ dictate the purchase of life insurance and not emotion!

Jay Kabad, CFP®, is President of Jaykay Wealth Advisors, Inc, a Houston-based wealth management firm. He received his Graduate degree from IIT Madras and an MBA from University of Pittsburgh, PA in 1980 and has been in business for 29 years. He is a Financial Advisor with LPL Financial and can be contacted at 713-780-4575. Securities and investment advisory services are offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC. The opinions voiced in this material are for general information only