Life insurance as an asset class
Life insurance is one of the simplest and most powerful forms of financial protection. But like other assets within your estate, your policies need attention. Left unattended, a policy bought years ago in a different economic climate and while your estate was considerably smaller (or larger) may not be meeting your original planning objectives. As interest rates have fallen over the past two decades, life insurers’ investment portfolios have experienced lower returns than were projected years ago. As a result, many insurers have reduced the performance on their cash value, whole life, and universal life products by lowering dividends and, in some situations, raising premiums or other fees. Any of these changes can affect a policy’s long-term performance and if not addressed, can have harmful results.
A policy review starts with your insurance agent or consultant ordering in-force illustrations from the insurer to evaluate how the policy is performing against expectations. These illustrations assess existing interest rate risk and will reveal the outcome if the policy remains in place versus revising the terms of the policy.
When some policies underperform, or a scheduled premium is not paid, an “automatic premium loan” provision within the policy will be triggered to pay the missed premium. The long-term consequences of the loan, and loan interest requirements, could become detrimental to your planning objectives. These loans may not have an immediate tax impact. However, if the policy is permitted to lapse or terminate with a loan that exceeds premiums actually paid with cash, the policy owner will have an income tax liability for the difference between the total loan and the actual premiums paid. A policy review is an opportunity to address this situation and to identify other potential issues.
Whole and universal types of cash value life insurance are commonly purchased for estate and wealth transfer planning goals. Both types of policies rely upon a rate of return on a cash value set by the life insurance company and guaranteed for a set amount of time. Even though rates have fallen over recent history, volatility is reasonably low, and performance is considered to be relatively stable. It is this stability that can aid in long-term planning, particularly when the death benefit is counted upon to meet future estate liabilities or to provide protection to a family or business due to an unexpected death.
Additionally, because a policy’s death benefit or cash value can be a meaningful part of your net worth, life insurance should be considered a separate asset class in that life insurance proceeds will be received tax free, and can be arranged to be received outside of your estate for estate tax purposes. The same stability counted upon for long-term planning allows life insurance to be easily analyzed and strategically added to a diversified investment portfolio. The death benefit and cash value of an insurance policy have a lower risk level compared to stocks or private equity and therefore can serve to balance a portfolio’s performance.
Reviewing your policies on a regular basis can keep you on track to meet your goals.
Krista J. Hinrichs is vice president of Wealth Services for The Sanibel Captiva Trust Company.