Maybe you don’t need to buy life insurance
Over the years I have heard people say they have enough assets so don’t need to buy life insurance. When they die the family, or the estate will be expected to liquidate an asset and pay any tax or other debts.
Some even say, “I don’t believe in Life insurance”. Fair enough, but life insurance isn’t a religion!
I have also heard “I’ll invest the premium, so I will have the cash when I die”.
I thought well maybe those that said they can invest rather than give the money to a life insurance company can provide the liquidity when it is needed. So, we ran the numbers.
Before I delve into things a little deeper let’s lay some of the groundwork.
A basic Term to 100 life insurance policy has a premium that will remain level with a level death benefit. Keep paying the premium every year and it will pay out a death benefit no matter when the insured dies. There won’t be any cash surrender values. We can measure whether putting money into a life policy is a “good investment” or not.
Let’s presume a 55-year-old male is considering buying a $1,000,000 Term to 100 life policy. The annual life insurance premium will be about $17,500. He has family and estate obligations he wants to cover. Let’s also presume his average Income Tax rate is about 36%.At his life expectancy (year 30) the Internal Rate of Return on a pre-tax equivalent basis for the $1,000,000 life insurance benefit is about 5.9%. Remember life insurance proceeds are normally tax free to the beneficiary. Not bad and certainly better than a decent fixed income investment. Maybe even better than some equities.
One option is to not buy the life insurance but save the annual premium amount in an investment account. Remember we are not trying to hit the ball out of the park, just to invest in a comparable investment vehicle to provide $1,000,000 upon his death.
Maybe he can do it without buying life insurance.
So, the client goes to his bank and lays out his plan.
The banker, rubbing his hands together in glee and eager to get the regular deposit, ran the numbers.
“Well, Mr Client, we will be happy to set up an account to save for your estate needs, but:
We don’t have a fixed income investment that guarantees a 5.9% pre-tax interest rate for about 30 years. In fact, in today’s economy we can’t guarantee that rate in anything”.
Also, Governments aren’t going to guarantee the income tax rates for 30 years!
But he might be able to do it if he could invest at that rate of return.
His investment account value, after income taxes are paid every year, will look like this at:
Year 10 $216,000
Year 15 $358,370
Year 20 $529,830
Year 30 $1,000,000
So, he can save the money BUT there is one other guarantee…
He has to guarantee he won’t die until his life expectancy.
The client decided it came down to guarantees. He was comfortable with the $17,500 annual deposit. It was a case of who could do better. The Banker or the Insurer?
· The banker has to guarantee the equivalent investment rate for 30 years
· The Client has to deposit $17,500 every year for at least 30 years AND guarantee that he will not die before his life expectancy.
· Deposit $17,500 each year into a $1,000,000 Term to 100 life insurance policy.
· Have an insurance company guarantee $1,000,000 cash payout no matter when he dies
So, there it is. The client could match the insurer’s guarantee of $1,000,000 at life expectancy and self insure but only if the three guarantees are in place.
The alternative is to pay a fee to an insurer to take on the risk.
In reality that fee is a deposit into an insurer’s financial contract that accepts the transfer of risk and provides a decent rate of return to the individual.
Sometimes guarantees are worth paying for