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Life insurance was never designed as an investment. However, life insurance companies have refined this product over many years to accommodate consumer demand and regulatory requirements. Today, you can buy a life insurance policy that functions as an investment. There are three kinds of policies that allow you to do this.



Whole Life Insurance

Whole life is the simplest policy type used for investment purposes. A whole life insurance policy provides guaranteed death benefit coverage for the entire lifespan of the person being insured by the policy. However, it also provides a cash value reserve component.

A substantial portion of the premiums you pay for a whole life policy must be used for this cash value reserve. The reserve functions similar to a savings, which may be used during your lifetime for any reason, and is normally invested in the insurance company's general investment account comprised of bonds and bond-like investments.

Transforming your whole life policy into an investment requires that you pay premiums in excess of the policy's minimum required premiums, shorten the traditional premium paying period of the policy, or do a combination of both.

A special modification to the policy contract, called a "paid-up additions rider," allows you to make additional premium payments over and above the minimum premium requirement. These extra premium payments purchase additional paid-up life insurance. This additional death benefit comes with its own cash value. Because the insurance charge on the paid-up life insurance is often waived or reduced, the policy's cash value is allowed to grow more rapidly than under the guaranteed schedule. This effectively makes the policy an investment since the insurer uses substantially all of your additional premium payments for investment purposes rather than charging you for ongoing insurance costs associated with additional death benefit protection.

Another method for turning your whole life policy into an investment involves shortening the traditional premium payment period. This is accomplished by using a limited-pay whole life contract. Limited-pay policies allow you to invest your premiums with the insurance company for a longer period of time than if you had paid premiums over your entire lifetime. This longer investment cycle, in turn, results in a higher cash value over the life of the policy.

Examples of limited-pay policies include 10-pay or 20-pay whole life contracts. These contracts truncate the premium payment period to just 10 or 20 years, respectively. Limited-pay policies are often flush with cash and are ideally suited as a source of supplemental income during your retirement years.


Universal Life Insurance

Universal life insurance, sometimes referred to as a UL policy, eliminates most of the guarantees of a whole life policy. Instead of a required premium payment, you are allowed a flexible premium payment and death benefit schedule. This flexibility allows you to change your premium payment and death benefit amount whenever you want.

When you give money to the insurer, it deposits your money into a cash value account. The insurer then deducts all expenses and fees for the policy. Finally, the insurer invests the remainder of the cash value into one of two investment accounts: the general account or the separate account. Investing in the former means you're buying a fixed UL policy, and investing in the latter means you're purchasing a variable universal life policy.

The general account is comprised of bonds, mortgages, and sometimes common stock investments. The separate account is comprised of mutual funds. If you choose a variable universal life policy, and thus invest in mutual funds, you are responsible for choosing the funds you want to invest in. If you choose a fixed UL, and thus elect the general account option, the insurer controls all investments.

If there is ever a time when the cash value account reaches $0, your policy terminates and you lose your life insurance policy. The insurer specifies a minimum guaranteed interest rate and a maximum guaranteed insurance charge for fixed UL policies. For variable life, there is typically no guaranteed interest rate, but there is a guaranteed maximum insurance charge.

When your insurance agent explains how your policy works, he may show you two illustrations. One will reflect the guarantees of the policy. The other will reflect assumptions showing lower insurance charges than the guaranteed maximum and higher interest rates than the minimum guaranteed rate.

Insurers also specify a "target premium." This premium amount indicates the minimum amount of premium required to keep the policy in force if the insurance company's assumptions about insurance costs and investment performance are accurate. If the assumptions turn out to be wrong, you will never realize the illustrated rates initially shown to you by your insurance agent.

It's important to recognize that the insurance company may increase the insurance charges, above the assumed rate, up to the maximum guaranteed rate. For fixed UL policies, the insurer may reduce the interest it credits to your cash value down to the guaranteed minimum rate. Altering either of these variable components in your UL policy means that your cash value may end up being very different from what the original policy illustration shows.

Using universal life as an investment is simple: tell your insurance agent that you would like to elect "minimum death benefit/maximum cash value" as the death benefit and premium payment schedule for your policy. This will reduce the death benefit to the lowest possible amount relative to the premium payment you make. It will also reduce the insurance charges associated with your policy to the lowest possible amount. This, in turn, maximizes the cash value available in the policy. The more cash value available for investment purposes, the better.

Electing "minimum death benefit/maximum cash value" means you're maximizing the amount of cash value available for investment purposes, and you're maximizing the interest being credited to your cash value account.


Variable Life Insurance

Variable life insurance works somewhat similar to whole life insurance in the sense that premiums are generally fixed, and so is the death benefit amount. Variable life differs from whole life in that policy values are generally not guaranteed. Some, or all, of the premium payments are allocated towards the insurer's separate account. Your policy's cash value and death benefit are determined by the performance of the investments in the separate account.

Using variable life as an investment is pretty obvious. You must apply for insurance coverage and pay the required premiums. Then, make sure that you choose mutual fund investments that perform well.


Considerations

You have two options for accessing the money in your policy. First, you may withdraw money from any universal life policy up to the total net cash value amount available in your policy. If you withdraw any amount in excess of the total premium payments you've paid, the IRS assesses income tax on the excess as investment gain. Policy loans are your other option.

A policy loan allows you to borrow money against the value of your cash value account at a low or net zero percent interest rate. The insurer gives you a loan and secures your policy's cash value as collateral without a credit application. Loans do not need to be repaid during your lifetime. If you do not repay the loan during your lifetime, the insurer deducts the unpaid loan amount from your death benefit and pays the remainder to your beneficiaries. As long as the policy remains in-force, all policy loans are income tax-free. Policy loans are your only option for accessing funds in a whole life or variable life policy.