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In my last article, I explained the
basic differences between term and permanent insurance. Permanent
insurance such as Whole Life, Universal Life, Equity-Indexed
Universal Life and Variable Universal Life is regularly promoted as
the perfect retirement vehicle or the new way to build wealth. This
week I will expose the fallacies of those arguments.
First of all, I believe that the need for life insurance should be
met in the most economical way possible. With universal insurance,
where life insurance is combined with investing, you end up paying
too much for the insurance while earning too little on the
investment. It’s the worst of both worlds. Term insurance allows you
to purchase the life insurance you need at a lower cost, while
giving you the flexibility and control over your investments.
Universal policies unnecessarily lock you in. You’re committed to
paying a high annual premium. For instance, the annual premium on
one million dollars of universal life for a healthy, 45-year old
non-smoking male is around $8,000. That’s $8,000 each year---for the
rest of his life.
On the other hand, the annual premium for one million dollars of
20-year term insurance is about $1400. That’s a difference of $6,600
each year. With universal insurance, most of that additional premium
builds the cash value of the policy. But because of administrative
and other fees, the amount added to your cash value each year is
reduced. By the way, has your agent mentioned there is a way to buy
no-load universal life insurance?
Insurance agents tout universal policies as a wonderful investment
vehicle. They’re not. Better returns can certainly be found
elsewhere. Many of these policies are pitched to people in their
prime earning years, most of whom are raising their families.
These investors will earn a far better return by first paying down
their debt. That’s a guaranteed return, of up to 20% on credit card
debt. For those without debt, any extra money they have is better
used for 401Ks, IRAs, etc.
The tax benefits heavily promoted as a major benefit of universal
insurance are suspect as well. It’s true that money drawn out of
these policies for retirement spending isn’t taxed, but that’s
because this money is actually a loan. In essence, you’re borrowing
your own money. And since it’s a loan, it has to be paid back.
If you hold the policy until you die, a portion of the death benefit
is used to pay back the loan. If you surrender that policy, the cash
value is used for that purpose. Suddenly that money isn’t tax-free.
Just like you may have to pay capital gains taxes when you sell your
home, you will have to pay taxes on the amount of the cash value
that is greater than the amount you paid in premiums.
Last of all, you need to be aware of the tremendous financial
incentive agents have in selling universal life insurance policies.
Commissions on universal insurance are 70% or more of the first
year’s premium, then 5% of the premium each year after.
One of the most egregious sales tactic used to promote universal
policies as an investment is that you should take the equity out of
your home and ‘invest’ it in a universal life insurance policy. The
argument is that your home equity is an asset that should be used,
not left dormant. The tax benefits are also touted—the transfer is
tax-free, the growth is tax-free and the distribution is tax-free!
That’s triple compounding, they say.
Do not fall for this trap. Frankly, those recommending it should
lose their licenses. The arguments used to support this scheme are
all smoke and mirrors. The tax benefits are bogus, you lose control
of your money and the agent earns a big fat pay day.
Nor will the earnings be what you expect. Most of the time you will
end up paying more in interest on your home equity loan than you
will make in the policy. The distribution is tax-free, but all death
benefits paid on life insurance policies are tax-free. So you can
leave the equity in your home, buy a term life policy and have the
same tax-free distribution benefit.
Have a financial question? Send me an email and I’ll personally
respond, free of charge. Go to www.guardingyourwealth.com and click
on ‘Ask Jeff’.
In addition to being a nationally syndicated columnist and Certified
Financial Planning Practitioner, Mr. Voudrie provides personal,
private money management services to clients nationwide. |
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