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Magazine Features
Safer Investing Tools
by Jared Garrett - WeXL Business Solutions
Investing for your future doesn't have to come with all the anxiety of the stock market.
With financial advisors urging people not to get too emotionally attached to their accounts, it's easy to fall into the trap of the bleak outlook regarding retirement. Because of this, a common question today is whether there exists a safe investing tool that can be used.
The answer is a qualified "yes."
The word "safe" has many meanings for many different people. However, the most common connotation is "risk-free." Essentially, people need to find out what tool they can use to invest their money for later life without the worry that they might lose all of that money. Good financial advisors will point out that there is no entirely risk-free way to invest money toward a comfortable retirement.
However, there is one risk-free way to invest money toward retirement: get completely out of debt, including your mortgage. Debt is a liability because you are legally bound to pay back the credit you have used. When you eliminate debt, you empower yourself to keep all of the money you earn, thus recapturing that interest you were paying to your creditors.
Remember that you absolutely must have a reserve put away in a savings account so that you are ready to handle life's emergencies. However, it makes little sense to pad a savings account that earns 0.5 percent interest while you could be using that money to pay down a credit card debt with 12 percent interest. So build your reserve, then pay down debt.
There are some other excellent tools that can be used that we could safely refer to as "very low-risk." We're talking about insurance-backed products.
Why Insurance?
Let's take a look at the stock market's history so that we can get some good perspective to start out with. Warren Buffet, who has studied 100 years of ups and downs in the stock market for the last 100 years, found that the average growth was 5.3 percent, compounded annually (2006 annual report to shareholders of Berkshire Hathaway).
The stock market is like a roller coaster, with moderate ups and downs as well as extremely steep growth and declines. If you invest in the stock market, your money participates in the growth, putting a smile on your face and money in your pocket. But if you don't cash out during a high, your money participates when the market loses.
What we're looking for is a tool that does not participate in losses; one that simply increases regularly. Savings accounts do this at an incredibly slow rate. However, indexed insurance is a powerful and safe tool for investing.
Indexed insurance products, as part of insurance companies, are regulated by state and federal agencies. Despite the incredibly bad press some companies like AIG have had of late, the insurance industry remains one of the most solid industries out there today.
Though AIG had bad press because of being overly aggressive in their investment strategies in certain areas, their annuities and life insurance are and have been regulated by state agencies; they could not invest that money anywhere dangerous, and these are still the company's healthiest offerings. This is the case for all insurance companies.
With that said, we can move on to indexed insurance products, such as annuities and universal life. If one of these products is indexed, that means it has both a floor and a cap—meaning it will never participate in market losses.
Specifically, let's say that you are using an indexed universal life policy with a floor of 2 percent and a cap of 15 percent. If the market grows at 9 percent, your policy grows at 9 percent. If the market grows at 17 percent for a given year, your policy grows at 15 percent - this is the cap. Finally, if the market declines for the year, say at a rate of -2.5 percent, your policy does not participate in that loss. You still have a growth of 2 percent for that year. Floors and caps very between providers, so this is just a hypothetical example.
This is the power of indexed insurance and annuities.
Some Specific Products
Let's take a few minutes to make sure we understand what an annuity is. Then we'll look at some indexed insurance policies.
Annuities
An annuity is a product that provides an annual income to its owner. The amount that you invest in the annuity, along with how long you leave it intact and do not take money or income from it, affect how much that income you receive amounts to.
More specifically, an annuity consists of two accounts: a cash account and a benefit account. The cash account tracks an index, like the S&P 500, and will lock in gains each year at the anniversary date. The income account indicates the amount of income you could receive from a certain date until the day you die.
Let's say that you have $100,000 to invest, or that is already in a retirement account. You choose an annuity. If you choose wisely, you find a provider that gives a ten percent (10 percent) bonus up front. What this means is that if you start with $100,000 that you put into your cash account, the provider adds a bonus of $10,000 right away. So your cash account now has $110,000 in it.
If you get a solid indexed annuity, you should experience an average of 8 percent yearly growth in your cash account. You can also add to it as you are able over the remainder of your earning years.
During those accumulation years, your cash account can increase every year, based on market growth and your contributions. If you have an indexed annuity, there will be a cap to that growth, but you will also never participate in market downturns. Then, when accumulation years are up and you are ready to retire, you activate your income. The insurance company will provide you a chart with the exact dollar amount you can access annually at any given year.
In short, annuities are not the kind of investment tool where you build up a sum of money to be cashed out at retirement. They are a tool that provides a guaranteed lifetime income benefit. You could very well cash out your account and get a lump sum from your annuity and try to stretch it throughout retirement, but the point is to have an income to live off of throughout your retirement.
This is why the indexed annuity is such a good tool. Your money might grow slowly, and it does in many cases, but you know the money will not disappear because the annuity is indexed. Furthermore, if you allow the cash account to grow for fifteen to twenty years before starting to take out an income, you will have a comfortable income that is guaranteed for the entire length of your retirement.
Keith Jacobson, a prominent Utah agent who is licensed in over twenty states, puts it simply: "I am simply amazed that my clients can utilize an annuity that provides them a ten to fifteen percent up-front bonus and a guarantee of eight percent annual growth for up to twenty years. It is not for everyone, but for certain clients, there’s nothing that can compare."
A final word on annuities: They are customizable to fit any client or need. You can set one up for a ten year period and then plan on cashing it out. In this case, your goal would just be to have a steady growth to your investment with zero downside market risk. Another option is to roll your current 401k or IRA into an annuity. An insurance professional can assist you in this process.
Life Insurance
Great life insurance agents teach their clients that a properly structured life insurance policy can protect your hard-earned money from five major risks:
- Market loss
- Increasing taxes
- Disability
- Death
- Frivolous law suits
Another feature of investing in life insurance as a retirement strategy is that life insurance grows tax free and the benefits from the policy come out tax free. For example, if you need to receive a death benefit from your policy, there will be no tax on the proceeds.
However, money withdrawn from your policy is technically taxable, which can be unpleasant. Taking a loan on your insurance policy's value - not like a loan from a bank - is a technical way to use the value of your policy without being taxed.
The danger of taking out insurance policy value as a loan is that you might take out the entire value of the policy. If this is done, you have essentially caused the policy to lapse. This means that the policy is no longer in effect and you have taken out a pile of money on a policy that doesn't exist anymore. Then the taxman arrives and wants his share.
To avoid this danger, good insurance providers offer a guarantee that they will help you keep from allowing the policy to lapse.
This brings us to a take-home message for today: If you have permanent insurance and you don't exactly know how it works or if you could be in danger of lapsing the policy at some point, you need a thorough audit. To do this, call your insurance provider directly and ask for an "in-force illustration." If your agent told you the policy is designed to accumulate cash to supplement retirement, ask that the illustration demonstrate what your goals are. his report will show if you are still on track with your original plan. If you have any questions as to the integrity of your agent, shop around - this can make a big difference.
As for what type of life insurance to invest in, there is no one answer. Certainly you want to seek out an indexed policy, but whether you go with universal, whole, or term is up to you, your situation, your income, and your needs and expectations.
For your information, here are definitions of universal, whole and term life insurance:
Term: This is what it sounds like. It is insurance that is purchased with a specific period of time in mind for the policy to function. This term can be from one to thirty years. During this time, your premium will be the same. This is usually the lowest monthly premium form of life insurance, but it is very expensive unless you die, because it builds no cash value. One critical point is that you want to have your term with a company that will allow you to convert to permanent at any time. Yes, the premiums will increase, but if you were to become ill and really need the insurance, you could convert it and keep it in place until you die.
Whole: This is insurance for the rest of your life. The premiums are higher than term life insurance, since the premium is supposed to stay the same for the entire life of the policy. There is also usually a guaranteed cash value to this type of policy.
Universal: Often referred to as "flexible premium, adjustable life." It offers a lot of flexibility if you need to decrease your premiums for a certain period of time. It also allows for the death benefit to increase or decrease as needed. Typically monthly premiums are lower than whole life, but certain guarantees aren't as strong.
There are three types of Universal Life:
- Traditional
- Indexed
- Variable
The details are long and complicated with these three, but the primary point is that they differ in how the accumulation value is credited. Traditional is determined by the insurance carrier as they see fit. Indexed is based on a specific market index and the cash value is not at risk of market loss. Variable is when the policy cash is invested into mutual funds with full upside and downside potential. There are pros and cons to each, but there is no silver bullet out there and definitely no one-size-fits-all solution.
Safety of Insurance Investments
It is worth taking a moment to explain what opponents of insurance as an investment tool might say.
First off, there is sometimes a worry that since the insurance companies make all the rules, they can change the rules of your policy anytime they want. This has only a little truth to it. Certainly rules can be changed and everyone wishes insurance companies were more transparent. That being said, when you purchase an insurance policy from a provider, you are making a contract. You must honor your end and the company is also legally bound to honor the terms of that agreement.
The other major problem that some financial advisors have with insurance as an investment tool is that it grows slowly. This is particularly the case at the beginning of the life of the insurance policy. The only way to make your insurance policy grow more quickly is to make a fairly large initial contribution. But remember, you're not trying to get rich quickly. You're planning for retirement and you are looking for a comfortable retirement income.
One fair caution financial advisors offer is not to invest solely in an insurance policy for your retirement plan. Look into CD's, which are FDIC (Federal Deposit Insurance Corporation) insured, and other instruments that have a guaranteed and secure income. It is always a good idea to avoid putting all of your eggs into one basket.
Final Words on Safe Investing
If you are looking to safely invest for your retirement, remember to keep your eyes on the prize. If you are like most people, you want to have a sum of money in place that will provide income throughout retirement. If you want that guaranteed, you probably want to look into an indexed annuity.
But always remember that you are your best investment. Find ways to increase your education, training, and skills base. Keep a vibrant professional network at all times. Explore methods of creating different income streams.
And remember, retirement doesn't have to be an age. It can be an amount!
Jared Garrett is a professional writer, business marketer, and consultant. To contact him, e-mail jgarrett@wexlbusiness.com, or visit his blog at personalfinancegym.blogspot.com.
**This article is intended only as an introduction to insurance investments, not as an exhaustive exploration.
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JEREMY in Huntsville, AL
This article is a little misleading. Term is the cheapest and best investment. If you spend $1000/mo on cash value vs $300/mo on term, guess what you get when you invest the $700 difference. A lot more money than the "cash value" of a whole life or universal plan. Also, when you die a cash value plan pays EITHER the cash value or insurance, NOT BOTH! In essence, if you have a $100,000 policy with $30,000 cash value and you die, they pay $100,000 but $30,000 was your money, therefore they only really insured you for $70,000. Meanwhile, you are paying a $1000/mo for a $100,000 policy but really only getting a $70,000 policy. With Term, when you die it pays the full policy and the difference you invested is yours to keep because it is in a seperate account not tied to the policy! ie you get both the $100,000 and the $30,000. So you telll me, which is the better investment.
Victoria in Tampa, FL
Jeremy in Huntsville, Alabama either is not familiar with investment grade universal life insurance, or he doesn't understand it. "Buy term and invest the difference" used to be the mantra when term was the best option. But with today's investment grade indexed universal life products that are created to be a "living benefit" for retirement rather than a typical death benefit, there is no other investment out there safe enough to build a retirement in right now. What happens when you purchase term and the 20 or 30 year term policy has matured? Now you are 20-30 years older and to find a new term policy will cost you 10 times what a universal policy would have cost if you had started it 20-30 years ago. And heaven forbid you should have a health problem that makes you uninsurable, you don't have any options anymore. And with Obama in office, anything you can do to protect your retirement from future taxes is well worth it. By the way, there is not a universal policy out there that you would pay $1000/mo for a $100,000 death benefit. The cost of insurance inside a universal policy is relatively inexpensive compared to a new term policy when yours matures. Also, indexed universal life has policies where you receive the death benefit AND your cash value at death. Do the research!! Tell me where you can invest the "difference" separately and still get market returns but not market losses? Hint.....there isn't anyplace.
Matt in MO
I am a financial advisor and help clients that are facing many of the issues in this article. I will agree that annuities and other insurance products are worthwile. However, they are only to be used in particular circumstances that I will not dwell on in this post. In fact, I have found that insurance products are by far the most missold financial products. The issue that I have with this article is that it only discusses the positives to purchasing annuities. For instance, it does not mention the high internal fees associated with annuities and the liquidity issues that are inherent with annuities. In the article they discuss using Equity Indexed Annuities but fail to mention the higher Contingent Deferred Sales Charge (CDSC). The CDSC is the size of fee you will be charged should you decide to pull your funds out of the annuity prior to a certain period. For example, John Doe purchases the annuity in 2009. John Doe decides that he would no longer like to own the annuity in 2011 and pulls the funds out. John Doe could then be charged as much as 15% of the annuities value for cancelling the annuity. In essence the CDSC is the amount of time that you must keep your funds in the annuity without being charged a cancellation fee. Most of the Equity Indexed Annuities that I have seen come with a 10 year CDSC penalty (10% if withdrawn in year 1, 9% year 2, 8% year 3, etc.). Furthermore, the article mentions taking the bonus of 10% up front. While this appears to be great, there are some big caveats. The 10% up front bonus comes with an increased CDSC penatly, which are typically in the range of 15% and draw down over the next 15 years. This means that you have to wait 15 years prior to liquidating the annuity otherwise you will pay a substantial fee(typically 15%). Another issue that I see with these products are the potential conflict of interest. These products are by far the highest revenues sources in my industry. The individual that sells you an Equity Indexed Annuity typically makes 20-25% of the purchase value. For example, John Doe purchases the Equity Indexed Annuity with 200,000 and Jack the Advisor will make $40,000-$50,0000! Additionally, Jack the Advisor has ZERO incentive to continue helping John Doe because Jack the advisor has already been paid. Also, they mention that Warren Buffet determined the Compound Annual Growth Rate (CAGR) to be around 5.5% and the annuity to get a return of 8-10%. The statement is fundamentally flawed. For starters, the CAGR of 5.5% for stocks over the long term assumes that taxes are removed from the return of the equity investment. The annuity may very well grow at an 8-10% CAGR but they fail to mention that this is a pre-tax return. The annuity operates similar to an IRA in the sense that it grows tax-deferred. The annuity, like the IRA, is taxed upon liquidation. Thus, they are comparing a pre-tax return to a post-tax return, which is not an intellectually honest way to compare any financial products. In fact, it is impossible to determine an appropriate investment vehicle without first understanding the tax implications associated with that product. In closing, I hope that anyone that takes the time to read this article and post will uses some of the information provided before purchasing an annuity product.
Caemron in Provo, UT
Whole life insurance is only a good investment for the person selling the policy and getting the large commission. You should buy term life insurance. Whole life insurance does not make sense as an investment.
Lynn B. in Rio Rancho, NM
I write this note to make a simple response to the comment by Jeremy from Huntsville, Alabama. 1.) Insurance should never be looked at as an investment. 2.) The internal rate of return on the "cash component" of many permanent policies is 4.5%/year or better. Added to that ... the money is growing tax deferred and could be withdrawn tax free (subject to policy provisions). You would be hard pressed to find a "safe" money deposit account that would be able to outperform the internal rate of return in a "safe" permanent Life Insurance policy. 3.) There are permanent Life Insurance policies that pay out BOTH the death benefit and the increasing cash value at death. 4.) How many "TERM" policies are in force when an individual reaches life expectancy (age 80 to 90)? The answer is .... VERY FEW. In essence, you have been renting coverage on a gamble that you aren't going to live to normal life expectancy. Don't get me wrong ... there are definitely reasons for the purchase of Term Insurance. It can be a very inexpensive tool and an important part of protecting risk. I just don't want the idea to be pushed forward that all permanent policies are a rip off ... because that is not true!
Steven in AZ
This response is towards Jeremy's explanation on how life insurance benefits are paid out. The article that was written mentions ways to invest within an insurance vehicle and having the money protected and earning a minimum or maximum interest amount over a longer period of time. Buying term and investing the difference is a concept one particular company has preached for many years. That is not to say that you can't make money with this concept but with the market experiencing the set backs that have occured this last year, many who invested with the buy term - invest the difference concept have lost a lot of profits on their investments. At least with the indexed type UL policy, the extreme losses won't occur and the compounding method will generate income at the end. A well informed insurance agent should know the ins and outs of the policy and how to maximize the returns and how much money needs to be paid in to the polciy to cover the cost of insurance and and what the maximum amount of cash the IRS allows to be deposited in order to obtain a specific monthly income goal while protecting your income. As for the money earned being deducted from the death benefit, this is only partially correct. If you choose option A death benefit for a UL policy, this usually does what Jeremy mentions, you get the death benefit only and they deduct any outstanding loans that may have been borrowed. Option B allows for the face amount of insurance plus the cash value of the policy to be paid out. So in this example if you had a $200K life insurance policy with $75K of cash value, a death benefit of $275,000 would be paid out.
JEREMY in Huntsville, AL
I should have made clear that the fees on 100,000 policy would be $30/mo for term and $100/mo for whole life. $300 and $1000 would be closer to a $1,000,000 policy. To Victoria in FL, and Lynn in NM, there are term policies available that are guaranteed renewable with term policies and have a premium based only on age regardless of health. At that point in time, for this policy that I speak of, your premium for term will not be 10 times more. In theory, there comes a point when people should be self insured and will not need any life insurance but will still need investments growing and or retirement income. Also, the time value of money for your money invested (the differnce)will more than make up for the increase in premium on your next 20-30 year policy on a guaranteed renewable term policy. Also, the fees charged on universal policies not premiums but extra fees that are taken out of your cash value (ESPECIALLY option B where the fees can be substantial), the fees and intrest charged when you want to "borrow" your own money, the commission paid to the person who sold it to you, and the fees charged if you cash it out early are all noticably higher or simply do not exist compared to a term policy. There is a small commission with term, but no fees. All those fees mentioned with a universal policy (which are in the fine print) are your money that could be invested. I believe this is the point Matt from MO was making and what I was inferring in my previous post. No, I am not saying that all insurance backed products are a bad investment, what I am sayimg is that they are if you are looking for or need "life" insurance. Once more, the main point I was really trying to make was that this article was misleading, as Matt in MO seems to agree, at least for some of the same reasons. This article makes term out to be bad and "cash value" insurance out to be the best think since sliced bread, and that is just not reality nor good investment advice. As for my opinion, this article reads like a salesman who is about to be paid a big commission on a cash value product and he is trying to sell it to me. By the way, Salespeople are paid big commissions for universal and other cash value policies. Companies only pay big commissions on a product if they make a lot of money on said product. Guess what? Companies do make a lot of money on cash value insurance. If they are making a lot of money, that means you are not. That means your money is being taken out of your pocket and not earning interest for you. Invest wisely or higher an honest financial advisor with an honest fee structure and a lot of experience and you will get your downside protection in a well constructed, well managed portfolio. As for "life" insurance, Term is the way to go.
Jared in Provo, Utah
Hey everyone. I am so pleased that so many people are feeling to comment on the issue of investments. As readers have seen, the ultimate truth of the matter is that insurance, whether as an investment or just a protection, is a complicated matter. I particularly appreciate the excellent clarification provided regarding the fees associated with cancelling annuities early. This would have been a good addition to the piece. Thanks!