TYPES OF LIFE INSURANCE
There are two broad classes of insurance policies. These are ‘term’ and ‘universal life’ policies (for simplicity, we have included ‘whole life’ policies under the rubric of universal life). Life insurance personal.
There are many considerations involved in making decisions regarding insurance. Broadly speaking, these considerations fall into four categories: beneficiary considerations, investment considerations, cost and ownership.
For most of us, one of these beneficiary justifications will be present. Therefore, the question then becomes whether there are reasons to purchase this insurance as part of a comprehensive investment strategy or whether the purpose of the insurance is simply to mitigate financial loss in the event of death.
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Term insurance provides no investment advantage in itself. There may be some advantage to an investor in terms of risk stratification. Investors who have an insurance policy as a back stop may be slightly more likely to invest more aggressively. However, the evidence for this justification is scant.
If investment is a primary consideration, a universal life policy is far more interesting. This policy offers the advantages of a managed security. However, insurance regulations allow value accretion and income to accumulate within the policy tax free. This represents a tax shelter for income. At the time of death, the proceeds of an insurance policy are not subject to capital gains or probate in most cases. Consequently, the wealth accumulated within the policy is transferred to the beneficiaries of the policy without incurring taxation. Thus, a universal life policy may represent an effective means of wealth transfer between generations. Whereas other securities incur capital gains taxation at the time of death (as a result of a deemed disposition), the insurance policy is not subject to these taxes.
The disadvantage of this strategy occurs when one attempts to withdraw income from the policy while he or she is still alive. In that event, penalties and taxation can become quite heavy. Income tax applies, capital gains are incurred and the policy usually has contractual penalties. A more effective strategy for income generation from these policies is to use the policy to serve as collateral for a loan. At the time of death, the loan can be repaid through proceeds from the policy, while the cash generated from the loan can support the lifestyle of the insured during his or her retirement.