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Time to Rethink Cash-Value Life Insurance

We started our careers in the era of 'buy term and invest the difference in mutual funds,' but market volatility has made this concept less appealing when planning for future needs that require certainty, writes financial-services attorney Judith Hasenauer.

Judith A. Hasenauer, 03/01/2012

The financial crisis of the past few years has caused average people to seek less volatile forms of saving to accomplish the two major goals desired by middle America--college educations for their children and a reasonable retirement for themselves. Demographics indicate that the critical age for planning for these goals is prior to 45.

Traditional cash-value life insurance can be an excellent vehicle for both of these goals. Even modest amounts placed in cash-value life insurance can result in a boon to the average middle class American. The tax deferral features of cash-value life insurance coupled with the potential for tax-free borrowing to pay college expenses and to provide retirement income make cash-value life insurance an essential consideration for financial planning for the middle market family.

Unfortunately, the delivery system for cash-value life insurance for the middle market does not seem to work well. It almost seems that the average life insurance agent cannot afford to sell the average cash-value life insurance policy to the average American. It would certainly appear that the tremendous advances in technology would make it easier for the middle market to obtain information about the advantages of life insurance to solve the two basic problems of the middle market.

We have stated in the past that it would be unusual for anyone to awaken in the morning with the realization that he or she needs to purchase a cash-value life insurance policy. Yet many consumers must awaken with the realization that they need to put aside funds to pay for their children's college education and to fund their own retirement. What's missing is the mechanism for these two concepts to marry so the consumer can recognize that the purchase of cash-value life insurance can be a solution to the problems of college funding and retirement.

Everyone in the financial services business is aware of the effectiveness of tax-advantaged investing. However, there are few such programs available. We started our careers in the era of "buy term and invest the difference in mutual funds." Unfortunately, the volatility of the stock market from the "dot-com" debacle to the terrorist attacks of 2001 to the bursting of the housing bubble have made this concept less appealing when planning for future needs that require certainty. Even variable life insurance has fallen on hard times because of the volatility of the economy. Yet, even with this uncertainty, traditional cash-value life insurance has continued to enable modest investors to plan their futures on a tax-effective basis.

The plethora of new regulatory requirements that apply across the board to virtually all financial products makes the job of the financial planner even more difficult. It almost seems as though the financial planner is held to the standard of being a soothsayer. If the market goes down and the client loses money, the financial planner must have done something wrong. In this context, the financial certainty of cash-value life insurance provides a haven for both the financial planner and for the customer. Even in these times of low interest rates, the amounts credited on high-quality cash-value life insurance products are one of the few remaining quality risk-free investments.

The structure of a cash-value life insurance product is important if the customer's financial goals are to be met. The most critical element is to establish the proper time horizon. People often fail to recognize how soon their children will be grown and need to have funds to pay college expenses. It is really necessary to begin funding for college expenses when a child is born, and it is never too soon to begin funding for retirement. Section 529 plans are so diverse from state to state that it is often confusing for consumers to sort out all the requirements. cash-value life insurance with the ability to borrow against the cash values is easier to understand provided that the financial advisor does not get too deeply involved in the mechanics of the product but instead focuses on the end result and the certainty of that result.

The forced savings element of cash-value life insurance is another benefit that cannot be underestimated. It is easy to procrastinate when time horizons seem to be far in the future. Yet, a regularly scheduled premium tends to foil procrastination. Most insurers have premium payment programs that make premiums seem to disappear, much like the income tax withholding that many people misunderstand. Yet, unlike income tax withholding--where taxpayers, in effect, make an interest-free loan to the government--life insurance premiums accumulate cash values for the benefit of the policy owner, free from income taxes.

The amount of cash-value life insurance in force in this country has diminished in relation to the population growth over the last 50 years. This is difficult to understand when considering the concern most of us have about income taxes. Yet, it probably results from the difficulty in supplying the necessary information to the middle market combined with the lack of an effective delivery system for such a market. We will have more to say on this issue in later columns.

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Judith A. Hasenauer, JD, CLU, is an attorney with the law firm of Blazzard & Hasenauer, P.C. She devotes her practice exclusively to the financial services industry, providing consulting on the development and regulatory clearance of products, compliance issues, distribution issues and related matters, such as advisory activities and industry initiatives.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.

The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.
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