There are few strategies that could be used to invest or generate extra cash flow through insurance products. Insurance is not exactly part of my usual topics but this post is part of the Insurance Movement hosted by a buddy of mine at Good Financial Cents. It shows the importance of insurance for everybody. Since there are a few ways to invest or generate a steady cash flow by using insurance, I thought it was a good angle to use for this blog. Did you know that insurance could actually generate some great returns? Here’s how:
Back to Back
The first strategy is for individuals aged between 65 and 75 seeking a stable source of income. Most older investors will get rid of their equities to buy bonds and certificates of deposit. Unfortunately, both investing strategies will lead them to struggle with inflation since today’s interest rates are so low. However, there is another option; they could buy an annuity.
The way an annuity works is quite simple; you write a check to an insurance company and it guarantees you a $ amount payable each year for the rest of your life. For example, you write a check of $100,000 in exchange of a yearly payment of $8,000 (so 8%). The amount of the annuity will depends on your age (this is why it becomes interesting only at 65 +). The problem with annuities is that they expire upon your death. So if you live only two years after signing the annuity contract, you got a very bad deal!
This is when the “back-to-back” expression comes into play. In addition with the annuity, an investor can also purchase a life insurance policy of the same amount. For example, you write your $100K check, get the 8K payment and buy a 100K life insurance policy (check out how to get the best term life insurance quotes). The payment will be quite expensive because you are over 65 (and this is why after 75, this strategy is useless). But between this sweet spot (65-75), you can pay something like $4,000 per year for such policy. Therefore, you are making a net of $4,000 (4%) from your investment! At your death, your estate will receive the $100K while you have been making 4% on your capital during the time of your life. Not bad, huh?
The downsides of this strategy are:
a) It doesn’t protect you from inflation (your 8K will always remain the same)
b) Your capital is frozen until the moment of your death
The upsides of this strategy are:
a) You can generate a higher investment return on your capital in a secured way
b) The tax implication of an annuity are better than interest income
c) Your capital is guaranteed
It’s a case by case scenario and it’s highly possible that your numbers don’t match this example. But I wanted to highlight the idea so you can discuss it with your insurance broker and make the proper calculations.
Investing Through Whole Life Insurance
Another way to benefit from your life insurance is to invest through the cash surrender value of a whole life insurance policy. Whole life insurance policies include a possibility to put extra money (once you have paid your premium) “inside” the policy. This account is called the cash surrender value (CSV). It’s a way to increase the value of your life insurance policy while investing in a tax sheltered investment account.
For example, if you have a 100K whole life insurance policy and you put an extra $500 per month in it (the $500 has to be over the premium you already pay), you will grow your cash surrender value account by $6,000 per year + investment returns/losses. This means that after a year, your life insurance policy will be worth $106K (+/- returns/losses).
The main advantage of this strategy is that you benefit from a tax free account. Profits earned within your CSV account are not taxable (since the insurance payout upon your death is tax free).
However, this strategy is also very limiting. You usually have to buy insurance mutual funds which show the highest MERs in the industry (not a good idea) and you can’t really access your money until you pass away. Insurance brokers will tell you that you can access your CSV at any time… but it’s actually a loan that you’ll be taking on the CSV. Meaning that you will pay interest to borrow your own money!
My thought on this strategy; use it once you don’t know what to do with your money anymore and that you have maxed out all the other ways to invest!
Do You Know Other Ways to Use Insurance to Generate Money?
I’d be curious to know if you have any experiences to share regarding insurance strategies. Here are a few others insurance articles I found interesting in this project:
An Overview of the Insurance Sector
Determine Your Life Insurance Needs – Thx to Excel!
Thanks but no thank you. My opinion, supported by a former insurance investments guy, is that the only person doing well with these products is the salesperson. The premium is out of this world! Interest rates are way too low.
Hey Michel!
you are probably right ;-), the insurance rep is definitely making a lot of money out of those products! but the back-to-back could be interesting for someone who can’t stand the market anymore. there is always a price to pay for security!
We use the SPIA-Insurance arbitration all the time at my office. We use it for 2 purposes:
1) The SPIA is not rated so you are getting a standard rating and then the life insurance is rated and maybe you are ultra or preferred.
2) The SPIA now takes an asset out of your taxable estate (we have estate taxes down here) and the life insurance can be owned by a trust which isn’t included
Very helpful article giving us the right insurance strategy. Having an interest low also tends to have a low risk one way or another there is always a risk. Thanks for this article.
I think many people do not realize they have other options out there. Real Estate in the US is a great source of income. Yes you need to structure yourself properly with lawyers, to reduce estate taxes, and it can be done easily. The Advantage is you can earn a high return, and still keep your full investment. You can pull out (sell your property if needed). You can even hire someone to manage your portfolio for you, which is where we come in. The Cash Flow in US Real Estate is high, and so will the appreciation over the next five to ten years.
If you do not want to invest in the US, then you can use your RRSP funds as a mortgage for other Canadian Investors. A normal rental property will not cash flow anywhere near as US properties, however you can setup Rent To Own Programs that will. It just means that in 3 years time, you would have to start the investment all over again, as that is when the tenant would most likely buy the property.
This strategy also works for US properties as well, just not with RRSP’s! Putting money in GIC’s or letting it “Sit in the bank” is a sure way to lose your buying power, as inflation runs higher than your GIC returns, before taxes!