Pet Peeves
Peeve 1 - “Be Your Own Banker”
Some life insurance agents have schemes to sell permanent life insurance. They are continuously devising new methods to disguise either themselves or the product; sometimes both at the same time; for example, calling themselves financial planners with no certifiable financial planning expertise. Or they call the insurance policy a “Private Pension Plan” and a “Super Roth”. “Be Your Own Banker” is another prevalent sales concept.
“Be Your Own Banker” is really just building a positive net worth. Net worth is defined as: Total Assets minus Total Liabilities. $15,000 of assets and $10,000 of liabilities equals a positive net worth of $5,000. Conversely, assets of $10,000 and liabilities of $15,000 equal a $5,000 negative net worth.
There are many types of investment vehicles that can be used to build net worth. Cash and equivalents, bonds, individual stocks, pooled investment funds, annuities, real estate, collectibles, precious metals and gems, and life insurance. Each investment vehicle has unique characteristics. An investor should understand their needs, constraints, and unique circumstances and the characteristics of the various investment vehicles, including life insurance, before investing. An overall Investment Policy Statement (IPS) can be developed to coordinate all these factors.
Permanent life insurance does have one very unique characteristic. It is the only investment vehicle that creates wealth in the event of death or disability. The death benefit creates an instant estate. A total disability waiver of premium, usually in the form of a rider, pays the premiums and builds your estate gradually just as if you were working and making the premium payments. In this situation, the cash value might be used as a living benefit for yourself. If the cash value is not needed, then the death benefit goes to your beneficiaries.
Permanent life insurance also offers tax benefits. The cash value grows tax-deferred and can be borrowed income-tax free. It is true that these tax attributes do resemble a Roth IRA. The advantage is that the income can be taken tax free at anytime. There are also no limitations, other than the amount of life insurance that the company will sell, on the amount that you can invest.
On the other hand, there are negative characteristics that make permanent insurance unattractive as an investment. First, there are the costs. The death benefit has mortality expenses that other investments do not have. It is also a front-loaded, high commission product that generates little or no value in the initial years. Second, only cash and equivalents earn a lower long term rate of return. Because of these two factors it will generally be in excess of 20 years before you could borrow from the policy without paying further premiums.
Remember this about life insurance. If you have to answer health questions and/or take a physical exam to qualify, you are investing in life insurance. Only invest in life insurance if: 1) you have loved ones that you care enough to provide for in the event of your death; and 2) they would suffer economic hardship. The correct amount of death benefit is the most important consideration, not whether it is a permanent or term policy.