Business owners should consider whole life insurance.
Many business owners poo-poo whole life insurance because they say it’s too expensive. Instead, they say buy term insurance (which is cheaper) and invest the rest. But the thing is, most people don’t end up investing the rest. So the money ends up going to other things.
But for some business owners, whole life insurance may be just what the doctor ordered.
First, let’s get a few facts out of the way. Term insurance is where you rent life insurance for a specific period of time. The average term policy is around 20 years. If you die during the term, your heirs will receive the face amount of the policy.
If you are still alive at the end of the term of the policy, you get nothing. In other words, you don’t earn anything on the money that you are using to buy life insurance. Nada. Zilch. A big goose egg. Obviously, you are not looking to win by buying life insurance. You are looking to protect your family if something should happen to you.
Whole life insurance, otherwise known as permanent insurance, is a type of insurance that will pay your beneficiaries when you die as long as you pay the premiums to keep it in force.
The premiums you pay are fixed. The policy is not for a set term, meaning that your heirs will get the insurance proceeds when you die.
Whole life insurance is more expensive than term insurance for several reasons.
- The insurance company will eventually have to pay your heirs, so there is a higher cost to insure you because the policy will pay out.
- Part of the premiums that you pay into the policy will be invested mostly in bonds by the insurance company and used to pay you a cash value.
- The cash reserve which builds up is tax deferred and usually guaranteed. You can withdraw up to the amount of money you put in the policy tax free, since it is a return of your principal.
- You can also take a loan against the cash value.
- The first few years’ cash value goes to the insurance company for administrative costs, and also as a commission to the insurance agent who sold you this policy. If you don’t want to use an insurance agent to by whole life, you can buy no load whole life insurance – just Google it.
I am a fee only financial planner. I don’t sell any insurance. But I think you may want to consider whole life insurance as part of your overall investment portfolio, especially if you are a business owner. Why? Here are my 5 reasons:
- You usually invest a lot of your money back into your business. While it’s always good to reinvest in your business, it’s also a good idea to diversify and invest in places outside of your business. Whole life insurance is a forced savings plan. You are buying this with after tax money in your name. After about 10 years of contributions, the cash value really starts to build up and grow. This could be a great way to fund your retirement. When you get the premium notice from the insurance company, you are most likely going to follow through and pay because you want to protect your heirs. Bottom line, you will keep paying.
- Your business is inherently risky. You could have 3 clients that make up 80% of your revenue. Or, your industry could be the 1st thing that people cut back on when the economy gets bad. So you want to invest in something low risk with some sort of guarantee — something to fall back on for peace of mind. Another way to think about it? If you’ve never been good at investing in stocks and stock mutual funds, whole life insurance could be a safer way to invest.
- Whole life insurance buys you flexibility in retirement. You could tap into the cash value in retirement or not touch it, spending down your other retirement assets, knowing that your heirs will inherit the insurance policy. The insurance policy gives you more freedom to spend your money if you still want to leave something to your heirs, like a younger spouse with a longer life expectancy.
- You want a line of credit to use for your business. But you can’t get a home equity line of credit or you don’t want to go through underwriting at a bank to get a business loan (it’s tough to get a loan if your business is down,) and you need money quick. You can borrow money from the cash value of your policy. If you do this, make sure you have a source of funds to pay this back. The last thing you want to do is invade an insurance policy’s cash value that took years to build up, and not have a plan for paying it back. That would be a major buzz kill. The current rates to borrow on a policy right now are somewhere around 6-8%.
- If you die and you don’t have a plan for who will buy your business, you know your heirs will inherit some money, no matter how old you are.
You need to do what’s right for you. That always the case. But before buying any type of life insurance, review all of the features, benefits, and costs with your insurance agent. Make sure you understand what you are buying.© Copyright 2012 Justin Krane, CFP