Does Using Life Insurance to Build Wealth Make Sense?

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Life insurance has become an increasingly controversial topic in recent years due to the opinions of financial gurus on YouTube, insurance salesmen, and media giants such as Dave Ramsey and Susie Orman. And so it's hard to know what's right and what's wrong with these types of policies that are out there and how they work. Rather than right or wrong, it really comes down to who is using life insurance and how they are using it. When it comes to building wealth, permanent life insurance is a potential option, but only in very unique circumstances.

Welcome, everyone, to the Retired-ish Podcast. I'm your host, Cameron Valadez, certified financial planner and enrolled agent. Today, we're talking life insurance. And more specifically, we're talking about using life insurance to build wealth. We're not talking about the traditional sense of using life insurance, which would be for a death benefit for some goal or estate planning reason, but building wealth. This is a very controversial topic for many of you out there. I even find it very controversial, and I'm a professional who deals with this stuff every day. For those of you who may have any preconceived notions about life insurance, please just let your guard down, at least for the next 20 minutes or so.

And I know there are some of you out there that say life insurance sucks, it's a waste of money, or maybe all you do is buy life insurance. I know that sounds weird, but I have literally met people who do this, and you may not understand much of anything about life insurance at all and the different use cases. And that's okay, too. It's a big topic, and it can be confusing at times.

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And many people have had different experiences when it comes to life insurance. Many of you have likely had one or two experiences in your life where you've sat down with some sort of life insurance agent or maybe a financial advisor, and you were pitched on some life insurance policy you didn't understand very well. Or maybe you actually were oversold, something that you later realized you shouldn't have bought, which, sadly, is often the case. That's why we're talking about it today.

I'm here to explain if and when life insurance should ever be used to build wealth specifically. I want you to be better informed so that you're prepared when you explore life insurance coverage or if you need to make a change to your current coverage or your plan. I've had the privilege over many years of working with people from all over the country, seeing how they've used life insurance successfully and others not so successfully. So, hopefully, my two cents can help you out.

All right, so let's dive in. There are essentially two types of life insurance products or chassis, let's call them. And since this episode is about whether or not you should use insurance to build wealth, I'm only going to dive deep into one type, and I will briefly discuss this first type of insurance since it's not really used for building wealth and that is term life insurance. This is the most basic form of insurance where you buy a certain amount of coverage over a specific time period to be paid upon your death.

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If you don't die within that time period, the policy goes away, and you have no more insurance. It's pretty basic. Term insurance, like I said, is not a vehicle that you would use to try and build wealth. It's simply for estate planning purposes for your loved ones or maybe a business partner in what is called a buy-sell agreement, for example, where money needs to be readily available upon one of their deaths to buy out the other business partner's share. Term insurance is used primarily to leave money to someone else to cover an expense or fund a particular goal that you had put into place. Term insurance is like most other insurance you pay in your life, where you simply pay the premiums, and then that money is gone forever. Again, it's not an investment, it's use it or lose it. And this type of insurance mitigates risks to your family and your estate plan.

And lastly, term insurance is typically the cheapest option compared to other forms of insurance because there are no other bells and whistles. Like I said, it's pretty simple. In my opinion, the vast majority of people who need or want life insurance should consider term, at least at first. If you don't have a ton of extra income and you just need some basic life insurance for your family and estate plan or something like that, term is likely the road that you will go down. And that opinion mainly stems from the fact that I want the people I work with at least to build wealth as efficiently as possible. And that means filling up the right buckets for investing and tax efficiency before considering any insurance-based methods. Most people I meet for the first time haven't locked down all of the efficient wealth-building methods that are available to them. So, in that case, I want their next dollar going to those strategies before they ever consider putting money into life insurance via the other main type of life insurance I want to discuss, which is called permanent insurance.

Cameron Valadez [00:05:58]:
Permanent insurance, or a permanent life insurance policy, typically costs more than term life insurance, usually much more, since it has some bells and whistles, one of which we call a cash value component. This essentially means that as you fund it and pay premiums for it, some of that money goes to the cost of insurance and other insurance company fees. And most types of policies can be designed to build up sort of like a savings account in the policy with some sort of interest rate or ability to grow with a rate of return, and that is called the cash value in the policy.

Now, the growth of the cash value is also tax-deferred, meaning you don't pay taxes on any potential earnings each and every year as you earn that interest, and more money gets to sit in there and compound at whatever rate of return you might get. Now, there are a couple of different types of permanent insurance. Those are what are called whole life and universal life. I want to focus on universal life for the remainder of the episode since most things that you can do with whole life, you can also do with universal. So, in the realm of universal life, you have a few different variations.

You have guaranteed universal life, which you can think of in a similar fashion to term life insurance, but the term is your entire life. It's just in a different wrapper, let's call it. It does also have that cash value component, whereas term insurance does not. Technically, the term on these is like age 125 right now. That's how the insurance companies design them. The insurance companies will generally pay out the death benefit, no matter when you might pass away, as long as the premiums on the policy are paid up. Then you have what are called variable universal life policies, also called a VUL for short. A VUL is, again a permanent insurance policy, but that cash value component gets invested typically in vehicles like mutual funds that have investments, maybe in the stock market.

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Therefore, the cash value component, or the investment bucket, let's call it, inside the policy, typically fluctuates over time. Those mutual funds will also have an internal cost added to the other costs of these VUL policies. The third type of universal life is what is called an indexed universal life policy, or IUL for short, which also has an investment component tied to the cash value. But instead of investing directly in, say, the stock markets through vehicles like a mutual fund, the performance of your money in the cash value component of the policy is indexed to some market, such as the S&P 500 for example. However, if you're not invested directly into it, then the insurance company typically caps you on how much of the performance of that index they will actually credit to your policy and give you. Many won't include any return that comes from dividends, for example, in that performance either.

And those caps on performance are yet another cost to you, since the insurance company gets to keep any money made over and above the caps that they set for your policy. A key distinction here compared to, say, the VUL is that the insurance companies typically set a floor on that cash value component, that investment component, meaning that your cash value can't decrease below a certain level, specifically from any market or index performance.

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Now, there are many other nuances and concepts to understand about these policies, such as flexible premiums and whatnot, but I want to stick to the basics of how these types of policies might be used if you're considering them as a part of your wealth-building plans. So when it comes to permanent insurance, the typical thing you hear is that you will be able to use it as your own bank, and there are even a ton of books written on this as well. This process stems from the fact that you can typically take loans or borrow from the cash value component and not pay any tax on that money because it's a loan. Then, you pay yourself back later with interest.

So you put the money back into your policy, and if you decide not to pay yourself back, the amount that you don't pay back simply decreases the value of the death benefit your policy has once you pass away and your beneficiary ultimately receives it. The key here is the loan component because if you simply withdraw the money out of the cash value rather than taking it as a loan, you will pay taxes on any of the interest earned in that cash value bucket before you get to the principal, or in other words, the money you actually put in. The other main premise of a universal life policy is that it is more expensive, at least at first, because much of your initial premiums go towards the cost of the insurance or the death benefit, for example. And then over time, the cash value hopefully builds enough to where it can pay for itself.

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By that time, you may also have a meaningful enough amount in there to borrow from, to pay for or fund whatever. So, you have a tax-deferred investment vehicle that you might be able to take out some tax-free money from later via a loan or even multiple times over your life. You might think that something like an IUL or VUL can be similar to maybe a Roth IRA. If used a certain way, you can think of it that way. But, there are still some major differences between an insurance product and a retirement investment vehicle such as a Roth IRA, and there are plenty of benefits and drawbacks to both. Now, we have discussed Roth IRAs many times on this show before, so I won't dive deep into the rules or recap any of that. But when it comes to something like an IUL, some of the major differences between the IUL and something like a Roth are that, for the most part, there are no contribution restrictions like you have with a Roth. Right? Roth IRAs have annual limits. You can only put so much into them. It's not that much money. You can put a heck of a lot more money into something like an IUL.

However, depending on the amount of death benefit that you buy on that insurance policy, you might be restricted somewhat on how much you can stuff into one of these things. But that gets a little too into the weeds for the purposes of this episode. Just know that typically, you're able to put a heck of a lot more into something like an IUL than you can in an account like a Roth IRA. There are also no income limits like you have with a Roth. There are fewer withdrawal rules and limitations because these policies are not retirement accounts.

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You can essentially redeposit funds multiple times throughout your life. Just as a disclaimer, I am not at all saying that you should necessarily compare these insurance policies to a Roth IRA. They are not the same. Each of them serves a different purpose. And as you may know, I love Roth IRAs, and I think they take precedence over something like a permanent life policy every day. But if you're a really high-income earner who's already maxing out every tax-efficient vehicle available to you and your family, then these insurance policies might be another option you consider, depending on your income and your plan.

All right, so what are the downsides? This sounds almost too good to be true, right? Well, the major downside is that these policies can be very expensive, not only from a premium perspective, cost of insurance perspective, or potential surrender charges if you try to take your money back out too early, but also from an opportunity cost perspective. Remember I mentioned that most of these types of policies have a cap on what can be earned inside of them, and your investment options are very, very limited.

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You won't have much control over the investments. So you might have been able to put that same money to work and some other type of investments, like the stock markets or real estate or some other investment, and potentially made a lot more than you can in one of these policies. The other major downside is that you may not be insurable to begin with. If you have certain health conditions that are likely to shorten your life expectancy, these insurance companies will either charge you an arm and a leg for the same amount of insurance, or they will decline you and not insure you at all, which takes the entire thing off the table. Okay, so let's look at how you can use these to increase your wealth-building efforts if they make sense for you in the first place. And we will stick with the indexed universal life policy just for the sake of our explanations. Now, the idea for these to really work is that you want to fund these policies with as much as legally possible, as fast as possible. So again, this is if you're already doing all of the other things we often talk about on this podcast, and you have a lot of extra income or assets, and you're looking for other potential options.

I can't caveat that enough. Like I briefly mentioned before, the issue is that depending on how much of a death benefit you go with on these policies, you can only fund these policies with so much before you turn the policy into what is called a modified endowment contract, or MEC. MEC, we like to call it. In summary, you don't want this to happen. You don't want to MEC your policy. Instead, the goal is to over-fund the policy as much as possible while avoiding an MEC overfunding, meaning that you put more into the policy than is required for the actual insurance component but not so much that you MEC the policy. There's a sweet spot for every policy, and it depends on its design.

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The insurance companies and your professional advisors can actually help you determine the right amounts to put into these based on your circumstances, and policies can be designed in a number of ways to help mitigate you from MECing the policy. One design of an IUL, for example, is called a cash accumulation-focused IUL. These IULs are designed to maximize the accumulation of the cash value, just like they say, easy enough. When working with a professional, you can properly design one of these based on how much in premiums you can and want to deposit or contribute and how quickly you can do so. This determines how much in insurance or death benefits you can buy or that you should buy, so you kind of work backwards. In a case like this, you aren't worried as much about the death benefit component, you would be doing it for the other potential benefits. So, if you're in this camp, you definitely need a solid financial plan in place before trying to get into one of these policies. In general, the larger the premium deposits or your ability to overfund, the more cash value you will have and less insurance, which means lower costs for the insurance component.

However, there are limits on how fast you can fund these policies, which again will depend on your exact circumstances to avoid the MEC. The goal of this strategy is to get the most amount of cash in while buying the least amount of insurance. Typically, those people who end up implementing a strategy like this completely fund these policies within ten years. Some do it in seven years, and the quickest is usually five years. And the key here is to be able to implement this strategy correctly. You need to see it through. By that, I mean you have to actually do it and complete the process. If you overfund one of these policies for the first few years and then you don't finish it out, you're likely to mess the whole thing up. Again, this is where that financial plan kicks in to tell us what we can and should do.

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The other component to some of these policies is that you can design the policy in a way that you either pay for a level death benefit, meaning the death benefit amount does not change over time, or you can have the death benefit increase over time. And when we actually look at the numbers, when you have an increasing death benefit, it typically decreases the amount you pay for the death benefit or the insurance component over time as the policy is funded. I know it sounds very counterintuitive, but that's typically how it works out if designed correctly. And remember, the goal with a strategy like this is to pay as little as you can for that insurance component. And not only that, but once your policy is paid for or paid up, and it's just about fully funded, you can typically switch to make it a level death benefit. So you can go from that increasing death benefit to the level death benefit later, meaning that you can lock in that amount of death benefit at the lowest possible cost.

Do these permanent insurance policies make sense for wealth building? Do they have a place in your overall portfolio? As far as these life policies go for the purposes of investing or building wealth, I would think of them as sort of like a bond replacement over a long period of time, and that's only if bonds even have a place in your overall portfolio, to begin with. Don't expect exuberant returns from these types of policies, and there might be times when they do generate a decent and acceptable return for you, but there will be other times when they generate no return at all.

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So, you also need to assess the costs associated with these policies and what other wealth-building strategies you've already implemented fully in your financial plan. Using life insurance to build wealth should really only be considered for those who have adequate means and typically very high discretionary income. If you don't, that's totally okay. I would say for most people, permanent life insurance doesn't fit into their plan because, again, they haven't done some of the other more cost-effective, low-hanging fruit. Not only that, but these policies have to be designed correctly per your situation and followed through on, which represents a potentially massive downside to these. If you get into one of these policies and you were promised you would be able to do all of these cool things like be your own bank, but then you start using it for things that weren't planned for initially, you're likely to blow the whole thing up and waste a lot of money.

So, if you're considering life insurance as a wealth-building vehicle, make sure to work with a competent professional. And from my perspective, sadly, these strategies or policies get oversold to people who aren't a good fit, usually by insurance agents or financial advisors who may not even fully understand the right way to design them, to begin with, and the purpose of this episode was to teach you some of the basics of when and why insurance might have a place in your wealth building strategy, and to arm yourself with more information if you do come to this point.

Hopefully, this was helpful, and you were able to learn a little bit more about the differences between some of these life insurance policies and why some people might utilize them as a tool in their portfolio.

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We will definitely discuss more on life insurance in a future episode, so be on the lookout. Thanks for listening. Until next time.

Hey guys, if you find the information and strategies I provide on the show actionable and insightful, please do yourself a favor and subscribe to or follow the show on your podcast app and share it with a friend who you think might benefit. And don't forget to sign up for the Retired-ish newsletter to get useful and easy-to-digest information on all things retirement planning, investing, and taxes. Once a month, straight to your inbox. No spam. Of course, if you want to learn more about the topics I went over in the show today, or you want to connect with us to see if permanent insurance has a role in your plans, or maybe you want a second opinion on something you're being sold, you can find links to the resources we've provided in the show notes right there on your podcast app, or you can visit us at retiredishpodcast.com\48. Thanks again for tuning in and following along. See you next time on Retired-ish.

Disclosure [00:24:38]:
Securities and advisory services are offered through LPL Financial, a registered investment advisor, member FINRA, SIPC.

The opinions voiced in this podcast are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.

The S&P 500 is an unmanaged index which cannot be invested into directly. Past performance is no guarantee of future results.

Variable Universal Life Insurance/Variable Life Insurance policies are subject to fees and charges. Policy values will fluctuate and are subject to market risk and to possible loss of principal.

Guarantees are based on the claims paying ability of the issuer.

This material contains only general descriptions and is not a solicitation to sell any insurance product or security, nor is it intended as any financial or tax advice. For information about specific insurance needs or situations, contact your insurance agent. This podcast is intended to assist in educating you about insurance generally and not to provide personal service.
They may not take into account your personal characteristics such as budget, assets, risk tolerance, family situation or activities which may affect the type of insurance that would be right for you. In addition, state insurance laws and insurance underwriting rules may affect available coverage and its costs. Guarantees are based on the claims paying ability of the issuing company. If you need more information or would like personal advice you should consult an insurance professional. You may also visit your state’s insurance department for more information.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Bonds are subject to availability, change in price, call features and credit risk.