Helping clients diversify their portfolios with life insurance

10/07/2024 — Key takeaways:

• Permanent life policies can be an integral part of a diversified portfolio and may offer stability and rate of return on death benefit to enhance investment strategies.
• Diversifying a portfolio can help hedge against volatility and inflation. It can also facilitate income planning for living benefits and funding an inheritance.
• Life insurance may be generally tax efficient, making it an attractive option for investors.

Most people think of life insurance as a helpful tool in protection and wealth planning. Your clients typically purchase life insurance to provide for their families if they die prematurely, provide liquidity at death, pay estate taxes and expenses, equalize an inheritance among family members, or help fund a business succession plan. Of course, these are compelling reasons to buy individual or survivorship life insurance, but you shouldn’t overlook the power of life insurance as part of a balanced portfolio. Many permanent life policies offer stability and rate of return that can enhance your clients’ investment strategies.

The importance of diversification

As a financial professional, you understand that diversification can be integral to sound investing. Diversification helps provide a safety net for the total portfolio: if one asset performs poorly, the loss may be offset by an unrelated asset performing well. Portfolios are likely to include both guaranteed investments for safety, and non-guaranteed investments for more upside (and downside) performance potential.

Diversifying a portfolio can hedge against volatility and inflation. It can also help with income planning for living benefits and funding an inheritance. While diversification doesn’t guarantee there will be no losses, it can generally minimize the overall risk of the client’s investments as a whole. 

Typically, financial professionals help clients diversify by choosing investments that are not highly correlated to one another. They may be spread across different asset classes, industries, and geographic regions. Life insurance can be an effective asset class option to add to the stocks, bonds, mutual funds, and annuities, and other financial instruments a client may accumulate.

Why use life insurance?

The rate of return on life insurance death benefit is typically not correlated to the stock market or interest rates. A set death benefit is paid at the time the insured dies, regardless of the national or global economic conditions. Life insurance death benefits may be a key component in income replacement, mortgage protection, tax efficient asset transfer, and business succession planning.

Most investments need time and contributions to grow and achieve investment objectives, and the account owner could pass away before reaching his or her investment goals. Uniquely, life insurance death benefit remains stable in the short and long term. The death benefit is generally a predictable amount, regardless of when the insured dies, no matter whether other assets in the portfolio are performing well or poorly.  While the death benefit’s actual rate of return will vary based on when the insured passes away, its performance is not correlated to the return of other assets the insured owns. 

Life insurance is also generally tax efficient. If policy ownership and beneficiary designations are properly structured, life insurance proceeds are paid income tax free to the beneficiaries. Furthermore, proceeds from a life insurance policy owned by a properly drafted and maintained irrevocable life insurance can be income and estate tax free. The beneficiaries may receive a higher after-tax rate of return from a portfolio including life insurance than one with only taxable assets.

Strategies for including life insurance as part of a balanced asset mix

Before purchasing a life policy, clients should collaborate with their advisors on whether there is a death benefit need. First and foremost, life insurance is designed as a protection tool to provide financial security at the insured’s death. Life insurance is widely regarded as critical to providing family support if a breadwinner or caretaker dies prematurely. It can also play a significant part in estate, charitable, and business planning. 

Death benefits

If death benefit is called for, you can help your clients determine how much they need and what type of life insurance makes the most sense for them. For example, depending on the policy’s primary purpose, the amount of death benefit may be a factor of income, net worth, or business value. Alternatively, the insured may have a certain amount in mind they wish to devote toward premium, and the amount of death benefit can be determined from there. 

Choosing the right policies

There are also several types of policies and pay structures to suit the individual’s needs. If the insured is only looking for death benefit for a certain time period, such as until retirement or children have finished college, a term policy could suffice. A term policy has no cash value component and is only in force for a certain period of time. An insured who is interested in accessing future cash value income tax free may prefer a permanent policy.  The value of a permanent policy typically grows as time goes by and premiums are paid, and the death benefit won’t expire as long the policy is kept in force. 

Permanent policies

If an individual opts for a permanent policy, they can choose whether they want the cash value to be invested in the stock market, participating in the market with caps on gains and losses, or invested with a fixed a return. Premium duration also varies: a policy can be structured to be paid up in a few years or have the premiums continue until death. Who to insure will also depend on when the death benefit is needed. A policy may insure a single person if the death benefit will be needed at his or her death, or two people if the need will be at the second death.

Keep in mind that cash value may vary and may be correlated to the return of other securities. The death benefit, however, can help diversify an investor’s comprehensive securities portfolio. Everyone has a different risk tolerance, and investors should work with their advisor on the asset mix that is appropriate for them. If life insurance makes sense as part of a client’s asset mix, financial advisors can help guide clients to determine the type of coverage, pay structure, and policy design that is a good fit for them. 

Final thoughts

Incorporating life insurance into investment strategies not only enhances portfolio diversification but also provides a protective layer for clients' financial futures. As financial professionals seek to maximize the stability and growth of their clients' assets, it can be important to recognize the strategic advantages that life insurance offers.