Peter Katt
Peter Katt
Insurance As an Investment

Why CPAs should give it a second look.

August 18, 2011
by Peter Katt, CFP, LIC

Thinking of life insurance as an investment can cause some CPAs to curse the subject and reject it out of hand. If you are one of these advisors you can ignore this column or bear with me and give the matter thoughtful consideration.

John, 42, is a very healthy, successful businessman with a wife and two young children. He has a net worth of $4 million. He is a commodity trader and his income fluctuates between minimal to $700,000 a year. He has a defined benefit (DB) pension plan with a $1 million life insurance. He contacted me recently to discuss a systematic investment/wealth transfer plan that would give him the flexibility of tapping into it for college-education costs, retirement or using it as additional inheritance for his children. Of significant importance to John is that this investment not be subject to creditors. He wanted to consider a $50,000 annual investment budget. He wanted to limit this to fixed-income investments because he takes a lot of risk in his business. His objectives tee this up for participating whole life.

My Analysis

“You requested that I review your possible purchase of life insurance for the three purposes of family protection, the possible tax-free withdrawal of cash values for college education expenses or retirement and estate wealth-transfer. Here are my comments and observations:

  1. For the purpose of this report the life insurance policy is low-expense Premier Mutual (PM) participating whole life (not company’s real name to avoid promoting it). The dividend rate is six percent that will change. PM has the highest possible financial strength ratings. I have analyzed policies for 30 years and believe PM’s values have consistently been the highest. I am assuming that you will pay premiums of $50,000 to age 65 or earlier and then zero premiums. The initial death benefit ($1.75 million) is the minimum amount to avoid modified endowment contract (MEC) status on such a policy. The secret to this design is in using minimum death benefits so it enhances the cash values and long-term death benefits.
  2. You are entertaining the options of owning such a policy personally or having it owned by an irrevocable life insurance trust (ILIT). If it is owned personally, you will have easy access to cash values to supplement retirement, etc. If it is owned by an ILIT, you will have a difficult time getting access to cash values.
  3. I spoke with an Illinois tax attorney that you may hire at my suggestion. He believes cash values are out of reach of creditors in Illinois even if you own the policy. If the policy is in an ILIT he also believes the cash values and proceeds are not in reach of creditors.
  4. One illustration I presented showed premiums of $50,000 for 15 years, when your children will be in college. You can withdraw up to $750,000 tax-free for these expenses. On the other hand if you are able to fund college from your current earnings, you won’t need these cash values and they would be fully available for retirement.
  5. Another illustration I presented showed premiums of $50,000 for 23 years to age 65 then tax-free withdrawals of $115,000 for 10 years from age 66 to 75. That is, you fund the policy with combined premiums of $1,150,000 to age 65 and then withdraw the same amount during the next 10 years. At age 75, based on the current six percent dividend, the remaining cash values are $2,042,264 and the death benefits are $2,981,014. If you own the policy personally after withdrawing your cost basis and depending on the estate tax, you would probably gift the remaining policy into an ILIT. Your life expectancy is age 86. Assuming $50,000 premiums are paid in over 23 years, annual withdrawals of $115,000 for 10 years and death benefits of $4,133,423 at age 86, the overall internal rate of return (IRR) is 5.39 percent, which is entirely income tax-free (pretax equivalent of 7.9%). This amount will change as the dividend rate changes. If the overall dividend rate is higher, the IRR is likely to be higher and vice versa. If this strategy is followed and the policy is gifted to an ILIT at age 75, the gift value would be approximately $2,042,264 (the cash value). If a gift of the policy is done, the policy will be in your estate for three years. The proceeds at life expectancy of age 86 would be estate tax-free.
  6. If an ILIT initially acquires the policy, the premiums of $50,000 are gifts. They would be offset by your annual exclusions and absorbed by Karen [John’s spouse] and your estate tax credits. Under this plan you are using the life insurance policy solely as a wealth-transfer asset. If you gift $50,000 to age 65, without any withdrawal of cash values, the illustrated death benefits based on six percent dividend at 86 are $7,261,968, which is a premiums-to-death-benefits IRR of 5.54 percent. This is income- and estate tax-free.
  7. Obviously, if we continue to have low fixed-income rates, PM’s dividend will have to fall and actual policy values will fall, but PM’s IRRs will continue to be strong versus conventional savings/investing outside of the life insurance policy. Conversely, if we experience a significant rise in fixed-income rates on a sustained basis, PM’s dividend rate will likely track the rising rates. In this sense this program is inflation protected.”


In John’s case, life insurance was an interesting option for two reasons. First, the cash values (up to cost basis) are income-tax free and so is the entire death benefit. The other reason is his desire to keep this asset out of the reach of creditors, while continuing to own it for his overall financial security. For John’s specific purposes, this life insurance is an excellent investment option that can be used for college funding or retirement.

I believe the problem with accepting life insurance as an investment for such things as college education is due to focusing on clients who should truly only be using term and expanding this focus to all clients. In my view, John is well served using permanent life insurance as part of his overall financial planning.

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Peter Katt, CFP, LIC, is a fee-only life insurance advisor since 1983, he has written insurance columns for AAII Journal and Journal of Financial Planning since 1991.

* DISCLOSURE: Readers should assume that all insurance advice mentioned in this column are the author’s and/or his firm’s unless otherwise noted and does not necessarily reflect the views of the AICPA or the AICPA Wealth Management Insider.