When Life Insurance Becomes an Asset

Aug 02, 2018

ASSETS VS LIABILITIES

From an accounting perspective, an asset is defined as something that will provide future economic benefit. A liability is considered an obligation, for example, money that is owed or work that must be performed.

Real estate master and professional teacher Robert Kiyosaki, defines these two terms very simply, “an asset is something that puts money into your pocket and a liability is something that takes money out of your pocket.”

TYPES OF LIFE INSURANCE

There are two main types of life insurance, Term and Whole/Permanent.

A simple metaphor can be used to highlight the differences between the two types of life insurance: renting a home versus purchasing a home. Think of a term life insurance as “renting” insurance. Rent is paid to occupy the home but it’s a short-term strategy and not an investment in your (or your family’s) future. The cost of the rent is not returned and provides no future long-term financial benefit—it’s simply the cost to live in the home today. Purchasing a home is an investment and over time usually builds value as the home appreciates due to market conditions. Unlike rent, the cost of the mortgage can be fixed over time and not continue to rise following the completion of each short-term contract period. And, the equity in your home can typically be accessed providing liquidity that can be used for other things life throws at you. Permanent life insurance is purchasing a life insurance policy with the expectation of keeping it until death. Permanent life insurance policies can hold cash value, provide liquidity through loans, and fund tax-free wealth to your heirs and estate when you pass away.

Term Life Insurance

Term life insurance is the simplest and least expensive version of life insurance. It pays out the policy benefit amount only if death occurs during the “term” of the policy. Terms last anywhere from one to 30 years and these types of policies are the most popular amongst consumers today.

Renewable Term Policies

Renewable term policies were at one point the most popular. Similar to health insurance, they would renew once a year with a new premium rate. These plans are not as attractive as they once were and a term policy with a “renewable clause” is what most people buy now. A renewable clause policy will allow you to renew your current policy with new rates when your plan expires.

This renewal will cost more money but will not require any additional medical underwriting. When you sign up for a life insurance plan they will conduct a comprehensive review of your overall health. Based on that review, (medical underwriting) and your age they determine your premium rate. For this reason, we recommend you get life insurance early when you are healthy and at less risk.

Convertible Term insurance

Having a “convertible clause”, or rider, in your policy is an absolute must and costs almost nothing to add, if it is not already included. A conversion rider allows the insured to convert their life insurance policy to permanent/whole coverage. When you convert this type of insurance into permanent your rates will most likely increase, however you will not be subjected to any medical underwriting. It gives the option to move from “renting” to purchasing the life insurance policy.

Whole/Permanent Life

Whole/Permanent life insurance is a plan that is purchased and the life of the policy is valid until you die. It is the other half of insurance that skips “renting” and allows you to “buy” insurance. This type of policy tends to be more expensive, however, it provides more financial value than just the death benefit. There is no life to this policy and as long as you don’t let the policy lapse then you are guaranteed the payment at death.

There are many benefits to whole life insurance including, coverage for an entire lifetime, it builds cash value, it has the flexibility to skip payments, it can potentially return more than the cost of premiums, it has tax sheltered accumulation/distributions, and they have the potential to be a good vehicle to use for generational wealth building.

IS LIFE INSURANCE AN ASSET?

Life insurance is most commonly viewed as a liability by consumers and financial advisors. According to Robert Kiyosaki, it is, in fact, a liability because it takes money out of your pocket. Well, that is not completely true. Most consumers are introduced to life insurance when they have a specific financial obligation, such as a commercial loan, a new family, a mortgage, etc. When your financial portfolio does not contain enough assets to completely cover the obligation, the need is obvious. But what about those who have the financial capacity to cover their liabilities? What if you have no mortgage or commercial debt? What if your family has long since grown up, moved out and is now self-sufficient?

Early in our lives and careers, we typically fall into the obvious need category for life insurance to provide security for our families should we meet an early death. But as we age, our net worth increases and changes from negative (when we owe much more in debt than we have in assets) to positive. Shouldn’t our perspective on how we view the need for life insurance change as well? What purpose does life insurance have for those who are more financially secure?

There are countless uncertainties in our world however there are two things that are certain, death and taxes. As much as we don’t like to talk about it, death is a certainty for each and every one of us. One thing that sets life insurance apart from other assets is the ability to cheat taxes with tax-free benefits paid to beneficiaries. With this perspective, the purpose of life insurance for the financially secure is that it can act as an investment in your legacy provided by the death benefit of the policy. Even conservative illustrations of returns on investment (ROI) for life insurance policies can yield double-digit returns. As an investment in the future of your family or charitable gift, life insurance is hard to beat.

Life insurance can also have a very real value to policyholders by selling policies to unrelated third parties. This is known as a viatical settlement, and in this marketplace, life insurance policies are treated as investment assets. Although the value of the policy can vary based on the age, health and face value, many policies can have significant cash value. For the financially secure who truly do not even need the legacy value of the death benefit, who would not want to receive a cash payment for something they no longer need? Rather than just throw it away, it may make sense to sell your life insurance policy and turn that annual premium bill into a cash windfall.

LET’S GET REAL: CASE STUDY

We recently worked with a client who was advised by his financial planner to lapse $4 million in term life insurance coverage originally obtained for business purposes. He is a healthy 70 years young and recently beat cancer. His net worth is over $10 million and his financial planner saw no need to convert his term policy into permanent Universal Life policies because the cost of the converted policies was about $60,000 annually. If he were to try and get a new policy today, at age 70, he would find significantly higher rates, or worse, carriers declining to offer any coverage at all.

Luckily, he also came to us for advice. We only sell policies with conversion riders. The cost is minimal and the rider provides options to the insured as they age and approach the end of the policy term. For this specific client, we advised him to convert the policy to permanent life insurance and then leverage his asset in the viatical market. Ultimately, our client decided to convert all $4 million in coverage, keeping $2 million of his new permanent coverage and selling the other $2 million for over $600,000. If he had lapsed his policies, as per the advice from his financial planner, he would have essentially thrown away a $4 million asset.

Our advice is simple, make sure you understand the value of your asset before you throw it away.

CONCLUSION

Not every case will end with these results. Life insurance has real value as an asset that can be invested for the future or leveraged for today. The purpose of life insurance can be flexible to our needs and wants throughout our entire lifetime. Our needs change over a lifetime and so does the value and purpose of life insurance. Understanding life insurance and how you can leverage it, is not easy. It is hard to comprehend and there are many ways to build your wealth. Having agents like PFSI adds tremendous value for you and your loved ones. Gathering knowledge of peoples’ financial goals and fully grasping the insurance industry is what we do best. Please reach out with any questions or concerns you have. We would be more than happy to assist you during your wealth building process.