A Word of Caution for Pilots
Pilots are often approached by insurance companies offering to sell them a wide range of policies. One of the policies pushed on pilots is permanent life insurance. Unlike term life insurance, permanent life insurance lasts for the duration of your lifetime.
The downside of permanent life insurance
While there can be important benefits to having lifetime insurance coverage in place, it’s possible these policies are being sold to pilots not for the death benefit they provide but rather for the cash value they accumulate over time. Some insurance salespeople promote these products as a “tax-free” source of savings and encourage pilots to use the policies as savings vehicles once they’ve maxed out contributions to their other tax-advantaged accounts. The problem with this approach is that using permanent life insurance as an investment may not make sense — a life insurance product’s primary purpose is providing a death benefit.
When an individual purchases a permanent life insurance policy, the insurance company invests the premiums paid into a fund. Here are some downsides to using a permanent life insurance policy as an investment:
- High costs – There are often significant expenses associated with permanent life insurance policies, and these expenses aren’t always clearly disclosed. At a glance, it may appear that the cost of purchasing a permanent life insurance policy is less than hiring a qualified wealth advisor; however, the complex nature of these insurance contracts may lead to you paying more in fees than you bargain for.
- Access to the cash value – When you pay premiums to an insurance company for a permanent life insurance policy, the cash value accumulates. You can “borrow” against the value and pay interest on the loan you can withdraw from the cash value, but gains will be taxed, and the death benefit will be reduced — or you can surrender the policy, but you’ll potentially incur a surrender charge, and any unpaid premiums or outstanding loan balances will likely be deducted.
- Reduced returns – It’s important to remember that your insurance contract may limit or cap investment returns, and returns above that limit are kept by the insurance company. And it’s the insurance company that gets to determine what percentage of those returns you actually receive.
- Commissioned brokers – The insurance representatives who sell permanent life insurance policies typically receive sales commissions. That means they may be incentivized to sell you a policy that’s not necessarily in your best interests.
- No control over your portfolio – When you pay premiums toward a permanent life insurance product, the underlying investments avaliable within the cash account are selected by the insurance company. Essentially, you’re limited to the investment options that the insurance provider offers.
- Tax implications for withdrawals – If you withdraw from the policy’s cash value, you may be subject to taxes on any assets in excess of the premiums you’ve paid minus any dividends you received. You may also be subject to taxes if you surrender your life insurance policy or fail to pay back a loan from the policy’s cash value.
Consider investing in a low-cost, diversified portfolio instead
Once you’ve maxed out your tax-advantaged savings accounts, such as your 401k and IRAs, it often makes sense to invest in a low-cost, diversified investment account rather than a permanent life insurance policy. The benefits of doing so include the following:
- Lower fees can enhance compounding over time –A low-cost, diversified investment portfolio can be a more efficient way to generate returns and build your wealth over time. Investing directly in stocks, bonds and exchange-traded funds (ETFs) can lead to significant cost savings over the investment funds available through an insurance company.
- You choose the investments that make sense for you –Because you have full control over the investments within the account, you can select an investment mix in line with your long-term goals.
- Flexibility to incorporate tax planning strategies –Investing in your own investment account allows you to take advantage of tax planning strategies such as tax-loss harvesting and asset location.
Situations in which permanent life insurance makes sense
Permanent life insurance can also have many advantages. Here are two situations in which these policies may make sense.
- Estate tax – The 2024 federal estate tax exemption is $13.61 million. However, this amount is scheduled to revert to $5 million after 2025 unless Congress takes action to extend it. Estates that exceed these amounts may face significant tax exposure. A permanent life insurance policy can be used to pay estate taxes and maximize the amount received by your heirs.
- Inheritance equalization – A permanent life insurance policy can come in handy if you have a single large, illiquid asset and multiple heirs. For example, say you have a piece of real estate worth $10 million and two children. Assuming no one wants to sell the property, only one child would be able to inherit it. A permanent life insurance policy with a $10 million dollar benefit can be a way to equalize the inheritance each child receives following your death.
How to get started
Not sure how to take the next step? Consider working with a qualified fiduciary advisor to establish an investment portfolio that makes sense for you, given your current financial situation and goals for the future. Fiduciary advisors, such as the professionals at Creative Planning, are held to fiduciary duty standards, which means they’re legally obligated to act in clients’ best interests. A fiduciary advisor can help ensure you have the right strategies in place to help lower your taxes and maximize your wealth building opportunities.
At Creative Planning, our aviation specialty practice is composed of experienced professionals who focus on helping pilots navigate the unique financial challenges of their personal and professional lives. To learn more about the pros and cons of permanent life insurance, or for assistance with any other financial matter, schedule a call with a member of our team.