Once dubbed the “boomerang” generation, millennials are slowly making their way into the homeowners market, and most regret it. A recent survey revealed that 63 percent greatly regret their decision due to the astounding amount of hidden costs associated with buying and owning a home. Whether it’s a struggling millennial who can’t figure out how to pay for a newly purchased house, a parent trying to figure out college tuition or an unexpected medical bill, the root of the problem is that most Americans are not financially equipped to handle unforeseen expenses.
While millennials are taking on second jobs to afford unexpected costs and expenses, high net worth individuals have known one trick to building wealth is permanent life insurance.
In a rare interview with Harvard Business School that was published online earlier this month, (it has since been taken down) value investor Seth Klarman spoke at length about his investment process, philosophy and the changes value investors have had to overcome during the past decade. Klarman’s hedge fund, the Boston-based Baupost has one of Read More
These life insurance policies are structured to accumulate cash value that can be borrowed against for a wide range of purposes, including making a down payment on a home, medical expenses, a new car, etc. During times of financial downturn, an individual with a permanent policy can avoid the hassle of interacting with a traditional lender by borrowing from the insurer and using a policy’s cash value as collateral. Not to mention, the money borrowed is often not considered income, therefore non-taxable.
The primary purpose of life insurance is to successfully transfer risk and protect families by supplementing the policyholder’s income when he or she passes away. However, with some careful planning, life insurance can be a smart investment and savings tool.
In general, life insurance products can be broadly broken down into three categories:
- Term - Avoid this policy. A term policy is generally an inexpensive policy that is valid for only a fixed time frame. A policyholder’s beneficiaries only receive a death benefit, if the policy holder dies within the terms of the policy. If the policy expires while the policyholder is still living, there are no death benefits or return on money invested in premiums paid. Term policies do not have a cash value, therefore no investment utility.
- Whole Life - This type of permanent policy offers both a death benefit and cash value component that can be used as a savings or investment tool. Whole life offers fixed premium payments over limited years, fixed insurance costs, high guarantees in cash values and death benefits and high stability in dividend yields. It may appear more expensive at first, but over time with risk and growth considered, whole life policies may not be necessarily more expensive. Not to mention, the policy should never lapse if premiums are paid, even if yielding only minimum guaranteed values.
- Universal Life - This policy also offers both death benefits and cash value that can be used as a savings or investment tool. Universal life policies offer non-fixed and non-guaranteed (often marketed as "flexible") premium payments over unlimited years. In addition, insurance costs are non-guaranteed and there are lower guarantees for limited number of years. However, the minimum guaranteed values alone are not enough to prevent the policy from lapsing. Some versions with variable or index features attached as a crediting method may have a higher potential to achieve higher returns than whole life counterparts, but not always necessarily. Risk in terms of both policy premium, policy charges and also market fluctuations in crediting method must all be considered.
If looking for a secure investment vehicle, whole life offers high guarantees and doesn’t require active portfolio management, but most importantly, it is a less risky investment because it is not directly tied to the whims of market volatility. For investing beginners, avoid flexible products, i.e. index or variable (or "flexible") products. These products tend to be significantly more complicated in structure and understanding, and often require advanced financial knowledge to navigate the terms.
The biggest misperception of life insurance is to only view it as a safety precaution to protect your family. Most people only begin to consider a policy after an impactful moment in their life, like the birth of a child, marriage or the loss of a loved one, but it should be viewed as an emergency fund for both the present and the future.
Regardless of the marital or parental status or age of an individual, investing in a life insurance policy should be done as soon as possible as to establish a low-risk foundation for present or future investment portfolios. Also, that investment helps individuals begin to build the cash value component of a policy as a nest egg that is safely out-of-sight and out-of-mind. It might even behoove Gen Z to learn from their predecessors now, and begin building and managing their financial future sooner rather than later to ensure future stability.