Can life insurance be an investment? Some experts argue that investing and insurance should be two distinct and separate parts of your financial plan. Buy term and invest the difference became mainstream thinking thanks to the likes of David Chilton and the Wealthy Barber.
In a world like today where confusion, complexity and information overload dominate, things may not be so cut and dry. The estate bond concept is an interesting one that takes life insurance and turns it into a potentially lucrative investment.
What is the estate bond?
The estate bond is an old life insurance concept that utilizes the tax benefits of life insurance to maximize your estate. The estate bond can multiply your savings by two, three and sometimes four or five times so you can provide a larger legacy tax-free for those you care about most.
I think the best way to describe the estate bond is to walk you through an example. Larry and Georgina are both age 65. They both have good pension plans. When you add the Canada Pension Plan and Old Age Security, they have a pretty good income to sustain a reasonable lifestyle. Larry and Georgina are not lavish spenders. In fact, most would characterize them as perpetual savers for a rainy day. Larry and Georgina have saved about $350,000 in investments in addition to their pensions.
Are they ideal candidates for the estate bond?
The estate bond is a concept that is really geared towards retirees who have excess income or excess assets necessary to sustain their retirement lifestyle. In Larry and Georgina's case, this is clearly the case. Their pensions alone are sufficient to provide the lifestyle they want. Their investment portfolio is excess that can be used to enhance their lifestyle. For Larry and Georgina, they felt that $100,000 could easily be used to provide an estate for their 3 children and 4 grandchildren.
Putting the estate bond to work
Here's how the estate bond is put to work. Firstly, the $100,000 is used to purchased a joint last to die life annuity. This annuity will pay $5,725.80 per year on an after tax basis (assuming a 32% marginal tax rate).
The next step is to use this annual lifetime income to purchase a Universal Life Insurance contract (face plus). For Larry and Georgina (non-smokers), $5,725 per year could purchase $375,000 of permanent life insurance. Already we have taken the $100,000 and turned it into a minimum of $375,000 of tax-free estate benefit.
Is this really a good deal?
The best answer to this question is to evaluate the numbers as if it were an investment and compare it to an alternative investment.
Now we have to start with basic assumptions about the rate of return on investments. Larry and Georgina are ultra conservative investors and they know that they do not need to take big risks to achieve their financial goals. Let's assume a conservative investment return of a mere 3%.
Now let's take a look at the life insurance policy compared to an alternative investment. For the alternative investment, we will be investing the $100,000 instead of putting it into an annuity. This investment will produce interest income of 3% per year. Of course, the 3% is taxable investment income so we will project the accumulation on an after tax basis.
In the first year, the life insurance has an estate value of $375,141. The alternative investment is worth $102,040. That's an estate difference of $273,101.
After 10 years, the alternative investment continues to grow and the accumulated value is about $122,378. However, the life insurance contact will provide an estate of $376,747.
At age 90, 25 years into the plan, the estate benefit of the insurance contract is $381,342. Under the alternative investment, the beneficiaries would get $165,677. In fact under every time frame, the estate bond outperforms the alternative investment as an estate benefit. From an estate perspective, there is no question that the life insurance contract is far superior to the alternative investment. The downside it there is little to no liquidity using the life insurance contract. So there is some merit to looking at life insurance as an investment for your estate. The estate bond is a great way to maximize the use of your assets to ensure that your heirs get more instead of the government.