We live in interesting times. Interest rates are at historical lows while stocks are at historical highs. Most experts in the financial industry would agree that stock valuations are stretched and there is currently quite a bit of risk in the stock market. Most financial planners would tell you that you need safe assets in your portfolio, especially as you approach or enter retirement. Safe assets are used for the money that you cannot afford to lose. Safe assets also stabilize the portfolio and protect from the losses that result from market fluctuations. Traditionally, this role has been fulfilled by cash and bonds. Unfortunately, cash is not earning anything these days and there is quite a bit of risk in the bond market due to rising interest rates. Bond values generally move the opposite of interest rates. This has been great for bond investors over the last 30 years as interest rates have continually trended downward. Over the next 30 years, interest rates are expected to increase which will hurt bond values. Most industry analysts expect bonds to earn nothing or paltry returns going forward. So, if we cannot use bonds or cash to stabilize a portfolio and still earn a decent rate of return, where do we turn?
One option is the insurance industry, specifically, life insurance. Life insurance can not only be used for the death benefit, it can be structured to produce a relatively secure, tax-free income stream in retirement. This can be accomplished with either whole life or indexed universal life; both policies offer guarantees.
In whole life, the insurance company invest in bonds and credits you interest after accounting for their costs and profit margin. The insurance company invests primarily in taxable bonds and holds those bonds to maturity. Therefore, they do not have the interest rate risk mentioned previously. If interest rates rise, that is good for a whole life policy in the long run. The policy will likely earn more as the insurance company earns more on the underlying bond portfolio.
The other form of life insurance that can be used for safe money is indexed universal life. The owner of this type of policy typically earns interest based upon the performance of a stock index such as the S&P 500. The guarantee comes into play when the stock market goes down. In these policies, your investment account never goes down, in fact it typically has a guarantee of 1-2%. So, what is the catch? In good times, your participation in the upside of the stock market is capped, typically at 10-11%. The idea is that if you understand these products and have the expertise to structure the policy properly, they can be used to generate a 4-6% tax-free rate of return. In today’s interest rate environment, that is pretty good for the safe portion of our portfolios, especially considering there are not a lot of good options out there right now.
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