Many Financial Advisors tout the benefits of using life
insurance as a savings or investment tool to help you
accumulate wealth for your future goals, but what about the
internal costs associated with life insurance? You may
wonder is this a cost prohibitive strategy? After all how
much of your money is going to pay for that large death
benefit pay out and what about the fees you have to pay the
insurance company to manage your money?
Surly all of these fees and charges do add up at the end of
the day but there are many things to consider if you want
to find accurate answers to these questions. The first
thing you have to understand when considering life
insurance as an investment tool is there are many ways to
structure a life insurance policy. The most common way the
typical life insurance agent goes about setting up your
plan is to first determine how much life insurance you
need. Then he or she tries to calculate, what is the
largest amount of insurance they can give you for the
smallest amount of money out of your pocket?
When a life insurance policy is structured using that
method a good portion of your premium dollars ends up going
back to the life insurance company in fees and insurance
charges. You will most likely be disappointed in the growth
of your cash value.
On the other hand there is an alternative way to structure
a life insurance plan that tends to go against the
conventional wisdom of trying to get as much death benefit
"bang for your buck" as possible. In this alternative
scenario the agent or advisor structures the plan to give
you the least amount of death benefit that the IRS requires
so that you can stuff your plan with the highest allowable
amount of cash that the law permits. Why would anyone want
less death benefit you ask? Because the lower the death
benefit in relation to your premium the less you pay in
insurance charges and the more cost effective your plan
becomes.
But you are probably wondering why go through all of that
trouble to calculate the correct proportions? How does that
benefit you? Well there are certain tax-benefits that only
properly structured life insurance contracts enjoy that are
difficult if not impossible to duplicate in other
investments. For example not only will the money you put in
your life insurance plan grow tax-deferred but if you do
this correctly often times you can access this money
tax-free.
Even with the added cost of insurance that you would pay
inside a life insurance plan vs. another type of investment
vehicle in many instances the tax-breaks alone can more
than make up for the added cost.
But let's look at those added fees for a moment. If your
contract is put together properly as mentioned above, it
most often works out that your costs are about 1% to 1.5%
over the life of the contract. Is this cost prohibitive?
Well, where would you put the money if you did not use a
life insurance contract? How can you really know if you are
getting a fair value unless you make an accurate comparison
to your other choices?
If you are like most people your first choice would
probably be investing in some sort of a mutual fund. But
what kind of fees does the average mutual fund charge?
According to the Chicago Tribune, Feb. 26th 2006 "The
industry average for mutual fund expense ratios or annual
costs is 1.3%" So the cost to invest in a mutual fund is
about the same as the insurance contract. But what do you
get for your 1.3% in a mutual fund? Advice, period. What do
you get for your 1.5% in a properly structured life
insurance contract?
You get an income tax free death benefit for your family
and tax-favored growth with tax-free access to our money.
If you choose the life insurance contract you are basically
trading the mutual fund expense charge (you would have paid
anyway) for life insurance charges. If you don't need the
insurance and you live to a ripe old age then good for you.
If you do need it, your family will be forever grateful you
chose to forego the mutual fund investment choice.
By the way so far we have only looked at mutual funds
obvious expenses but we did not even consider the many
hidden costs to owning mutual funds. For example most
mutual funds today have turnover rates in excess of 90%.
That means that they rarely follow a buy and hold
philosophy, and instead tend to sell about 90% of their
portfolios in a given year in order to buy different
stocks. Each time they buy and sell they incur transaction
fees that are passed on to you. We can only estimate how
much the funds pay in transaction cost because the funds
themselves do not even know that amount. In addition all of
this trading, costs the share holder additional expenses in
capital gains taxes and this is really just the tip of the
iceberg.
When you add up all of the fees inside a mutual fund the
average investor looses 3.1% of his investment returns to
these costs each year. John Bogle, the creator of the
Vanguard 500 mutual fund had this to say about the 3.1%
average fee of today's mutual funds, "That may not seem
like much but such costs would consume 31% of a 10% market
return. Add in the 1.5% capital gains tax bill the average
fund investor pays each year, and that figure shoots up to
46%, nearly half of a potential 10% return".
As you can see the fees inside of your average mutual fund
are twice as likely to eat away at your potential returns
than the modest fees in a properly structured life
insurance contract.
So what is the bottom line answer to the question, is life
insurance a cost prohibitive way to invest? Plain and
simple, it depends! Depends on what you ask? Is the
insurance plan structured properly? And where would you put
the money if it did not go into an insurance contract?
No matter where you invest your money there are sure to be
fees that go along with that investment. Life Insurance is
no different. However in the life insurance plan the cost
of the insurance is basically absorbed by avoiding mutual
fund management fees and otherwise payable income taxes.
That being said if you do decide to use life insurance as
an investment tool make sure that you are talking with a
qualified advisor who fully understands not only its cost
but also its potential.
----------------------------------------------------
Antonio Filippone is a respected speaker on a wide range of
subjects. He has been published in the official journal of
the IARFC as well as interviewed on the Radio about his out
side the box financial strategies.Readers who are
interested in gaining more information on how to live debt
free and truly wealthy can request a complimentary copy of
Mr. Filippone's booklet by visiting his website at
http://www.tonyfilippone.com
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