Broker Check

Mind Your Business: #7 Personal Life Insurance

| October 29, 2018
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Although life insurance should be an integral part of an entrepreneur’s planning, for a variety of reasons (be it the lack of time, knowledge, or trust in others to guide them) this decision is often put on the back burner.

Did you know there are four reasons successful individuals purchase individual life insurance?

1. Family Income

The first reason we buy life insurance is to provide income for the family if you were to pass away. For example, with my youngest being 12, if I were to pass away, my wife would still need a lot of income for a lot of years. The best product for this purpose is term insurance. While young and with limited dollars, this is the ideal time to buy term and invest the difference.

2. Estate Taxes & Liquidity

The second reason people buy life insurance is to cover estate taxes and/or estate liquidity needs. Today, although the amount of assets with which you can die and not be subject to estate taxes is at the very high $22.4 million per married couple, there’s no way to know what the tax laws will be or what decisions Congress will have made when we pass away (hopefully decades from now). Since this is considered a permanent need, term insurance is unable to serve this purpose, so some sort of permanent insurance is required.

3. Tax-Deferred Money for Retirement

The third reason people buy life insurance (although I am not a fan of this strategy) is to build up a tax-deferred source of money which at retirement can be withdrawn to supplement your other income to provide for retirement income. I may get a lot of slack for this statement, but I am of the opinion that this strategy is ill-advised because it increases your risk (most people, not even many life insurance agents, understand why). This strategy doesn’t adequately compensate you for the additional risk that you are taking. What I mean is that with most cash value policies, if too much money is taken from the cash value such that the cash value hits zero, then many times the policy will lapse, and the client will get an ordinary tax bill for the amount of cash value received above the policy cost basis. This is not a well-known fact, but it is none the less true.

4. Asset Allocation & Leveraging the Death Benefit

The fourth reason individuals will buy life insurance is two-fold. One, as the white paper by Richard M. Weber and Christopher Hause, titled Life Insurance as an Asset Class: A Value-Added Component of an Asset Allocation states, “A bond portfolio using life insurance nets a higher return with less risk than a bond portfolio without life insurance.”

Two, as evidenced by banks and corporations carrying billions of life insurance on their balance sheets (see line #41 for your own bank’s cash value on the FDIC website), the cash value is used as a safe, liquid asset on their balance sheet – they call it “Tier 1 Capital” (My bank, Wells Fargo, for example, has $18,568,000,000 in life insurance cash values).  In addition, they have figured out how to leverage the death benefit. For individuals, the death benefit can help people take a higher income from their retirement or other assets by leveraging this death benefit. Exactly how that’s accomplished is too detailed to cover in this blog but if done properly, for example, the existence of a properly designed and leveraged death benefit, you can potentially have, say, $5M of retirement assets spend like it was really $7M or $8M.

In summary, there are ways to use life insurance when you are starting out, pitfalls to avoid as your income and net worth grow, and ways to imitate banks as they have discovered the highest and best use of life insurance.

Up next, we’ll dive into #8 of the 10 Most Common Business Owner Blind Spots series – Succession & Buy-Sell Planning. Stay tuned!

 

References:

https://www5.fdic.gov/idasp/advSearchLanding.asp

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