Q: I’ve maxed out my savings with my Thrift Savings Plan and my Roth IRA. A financial adviser has suggested I invest in an equity-indexed universal life insurance plan because of the great tax benefits (I don’t have many other tax options that are favorable for me). I’ve got 35 years with the government and will retire in another five years or so. What do you think?
A: Unless you have a need for life insurance, and will have that need for the remainder of your life, I don’t think you have any business buying a universal life insurance policy as an investment.
To be fair, permanent life insurance products, such as universal or whole life, have some decent tax benefits. Any earnings will grow tax-deferred and any disbursements you take will be treated as withdrawing your deposits first, and any earnings second (this is the complete opposite of the horrible manner in which annuities are taxed). Furthermore, your “financial adviser” probably told you that you could “borrow” from your earnings, rather than withdrawing them, thereby eliminating any taxable income.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
While the tax treatment of life insurance can be favorable, the cost of the life insurance often outweighs any tax benefits you may receive. So, you could pay into a policy for years, but much of your earnings will get eaten up by charges the insurance company hits you with to cover the costs.
There may be a place for universal life insurance for some people, but it is so often misused and sold to the wrong folks, so, as a rule of thumb, I say stay clear of it. For every one person I see who is truly maximizing the tax benefits, I see 10 other folks who could do a lot better by purchasing term insurance and investing the difference.
Obviously, I don’t know your full situation, but I doubt you have a need for life insurance until your dying day. Once you retire, you’ll have the option of protecting your spouse by taking a reduced pension that will continue to pay your partner after your death. This is a form of “life insurance” to be sure, but it’s a much better deal than trying to replicate the benefits by taking a single life pension option and buying life insurance to provide your spouse with income once you die.
So unless you have some other reason why you’ll need life insurance for the remainder of your life, forget the universal life insurance. Simply, the costs are greater than the tax savings.
There are, however, some other tax-favorable options to save more for retirement. For example, why not simply invest in a low-cost mutual fund that mirrors an equity index? These provide some great tax benefits, as well.
When you invest in an index fund, any price appreciation in that fund will grow tax-deferred. For example, if you purchase a fund at $10 per share, and it grows to $25 per share, you are not taxed on that growth until you sell the fund. All that appreciation has been tax-deferred.Once you are retired and want to take some income from the fund, you can sell just a portion of your holdings (as necessary), while realizing favorable capital gains treatment. Or, if you want to avoid taxes altogether, you can take a loan against your shares, similar to the life insurance being pitched to you, and avoid any income taxes.
And if you are concerned that investing in a stock index fund may be too risky, you could simply reduce your holdings in your Thrift Savings Plan (the government’s version of a 401(k)), so you can keep your portion of conservative investments “relative” to risky investments in check.
Finally, I question whether the person recommending the life insurance product is acting in your best interests. Unlike financial advisers, who are affiliated with registered investment advisors, insurance agents and stock brokers don’t have to make recommendations that are in your best interests. There is no legal requirement for them to do so.
Rather than working with a financial adviser who sells products (such as high-priced life insurance), I suggest you find an adviser who is affiliated with a registered investment adviser (RIA). This type of adviser not only has an ethical duty, but also a legal obligation to only make recommendations that are in your best interest.
Given that you are saving the maximum toward your 401(k), contributing to a Roth, and you will retire with a government pension, you are on your way to a very secure retirement. Congrats.
-
Stocks Swing in Volatile Session: Stock Market TodayThe main indexes fell sharply in early trading on rising China tensions, but rebounded thanks to encouraging bank earnings.
-
Don't Miss Out! A Quiz on Medicare Enrollment DeadlinesQuiz Test your basic knowledge of Medicare enrollment periods in our quick quiz.
-
A 'Fast, Fair and Friendly' Fail: Farmers Irks Customers With Its Handling of a Data BreachFarmers Insurance is facing negative attention and lawsuits because of a three-month delay in notifying 1.1 million policyholders about a data breach. Here's what you can do if you're affected.
-
Five Retirement Planning Traps You Can't Afford to Fall Into, From a Wealth AdviserTo help ensure you reach your savings goals and enjoy financial security in your golden years, be aware of these common pitfalls. The key is to be proactive, informed and flexible.
-
Your 401(k) Can Now Include Alternative Assets, But Should It? A Financial Adviser Weighs InMany employer-sponsored plans offer limited investment options, which can stunt growth. But participants considering alternatives might need some sound advice to get the most from their accounts.
-
Will Taxes Shred Your 401(k) or IRA During Your Retirement? It's Very LikelyConventional wisdom dictates that you save in a 401(k) now and pay taxes later, but turning that rule on its head could leave you far better off. A financial planner explains why.
-
More Retirees Are Renting: Should You? A Financial Adviser Weighs InIn some ways, renting is cheaper, more flexible and easier, but unless you understand the implications for your taxes and health costs, it might not be for you.
-
I'm an Insurance Pro: Everyone Needs to Prepare for Earthquakes, Even if You Don't Live Near a Fault LineHere are my tips for what to do before, during and after an earthquake. The more prepared you are, the more you'll be able to keep your wits about you if it happens.
-
Where There's a Will, There's a Way Your Assets Will Be Distributed as You WishYour will is the backbone of a strong, adaptable estate plan that ensures what you leave behind goes to your selected beneficiaries. Without a will, state laws determine who gets your assets.
-
I'm a Financial Adviser: This Is What You're Really Losing if You Cut Back on Your 401(k) ContributionsMissing out on the benefits of the employer match and compounding growth could force you to work longer and lower your standard of living in retirement. Here are some alternative options.
