The Dirty Little Secrets Behind Life Insurance Fees

Have you ever read an article that claimed life insurance was not a good investment vehicle? I know I have so I decided to do some research and here is what I found out. It may surprise you. After all you are probably wondering how much of your money is going to pay for that large death benefit and what about all of the additional fees on top of that?

Surly all of these fees and charges do add up at the end of the day but there are many things to consider if you want to find accurate answers to these questions. The first thing you have to understand when considering life insurance as an investment tool is there are many ways to structure a life insurance policy. The most common way the typical life insurance agent goes about setting up your plan is to first determine how much life insurance you need. Then he or she tries to calculate, what is the largest amount of insurance they can give you for the smallest amount of money out of your pocket?

When a life insurance policy is structured using that method a good portion of your premium dollars ends up going back to the life insurance company in fees and insurance charges. You will most likely be disappointed in the growth of your cash value.

On the other hand there is an alternative way to structure a life insurance plan that tends to go against the conventional wisdom of trying to get as much death benefit “bang for your buck” as possible. In this alternative scenario the agent or advisor structures the plan to give you the least amount of death benefit that the IRS requires so that you can stuff your plan with the highest allowable amount of cash that the law permits. Why would anyone want less death benefit you ask? Because the lower the death benefit in relation to your premium the less you pay in insurance charges and the more cost effective your plan becomes.

But you are probably wondering why go through all of that trouble to calculate the correct proportions? How does that benefit you? Well, using a properly structured life insurance contract allows you to enjoy certain tax-benefits that are difficult to mimic in other investments. For example not only will the money you put in your life insurance plan grow tax-deferred but if you do this correctly often times you can access this money tax-free.

Even with the added cost of insurance that you would pay inside a life insurance plan vs. another type of investment vehicle in many instances the tax-breaks alone can more than make up for the added cost.

But let’s look at those added fees for a moment. If your contract is put together properly as mentioned above, it most often works out that your costs are about 1% to 1.5% over the life of the contract. Is this cost prohibitive?

Well, where would you put the money if you did not use a life insurance contract? How can you really know if you are getting a fair value unless you make an accurate comparison to your other choices?

If you are like most people your first choice would probably be investing in some sort of a mutual fund. But what kind of fees does the average mutual fund charge? According to the Chicago Tribune, Feb. 26th 2006 “The industry average for mutual fund expense ratios or annual costs is 1.3%” So the cost to invest in a mutual fund is about the same as the insurance contract. But what do you get for your 1.3% in a mutual fund? Advice, period. What do you get for your 1.5% in a properly structured life insurance contract?

You get an income tax free death benefit for your family and tax-favored growth with tax-free access to our money. If you choose the life insurance contract you are basically trading the mutual fund expense charge (you would have paid anyway) for life insurance charges. If you don’t need the insurance and you live to a ripe old age then good for you. If you do need it, your family will be forever grateful you chose to forego the mutual fund investment choice.

By the way so far we have only looked at mutual funds obvious expenses but we did not even consider the many hidden costs to owning mutual funds. For example most mutual funds today have turnover rates in excess of 90%. That means that they rarely follow a buy and hold philosophy, and instead tend to sell about 90% of their portfolios in a given year in order to buy different stocks. Each time they buy and sell they incur transaction fees that are passed on to you. We can only estimate how much the funds pay in transaction cost because the funds themselves do not even know that amount. In addition all of this trading, costs the share holder additional expenses in capital gains taxes and this is really just the tip of the iceberg.

Once you add the 12b-1 fee to the estimated transaction fees along with the added capital gains tax the average mutual fund investor looses 3.1% of his investment returns to these costs each year. John Bogle, the creator of the Vanguard 500 mutual fund had this to say about the 3.1% average fee of today’s mutual funds, “That may not seem like much but such costs would consume 31% of a 10% market return. Add in the 1.5% capital gains tax bill the average fund investor pays each year, and that figure shoots up to 46%, nearly half of a potential 10% return”.

As noted above when you look at the fees inside the average mutual fund they can add up to more than double the fees in a properly structured life insurance contract.

So what is the bottom line answer to the question, is life insurance a cost prohibitive way to invest? Plain and simple, it depends! Depends on what you ask? Is the insurance plan structured properly? And where would you put the money if it did not go into an insurance contract?

No matter where you invest your money there are sure to be fees that go along with that investment. Life Insurance is no different. However in the life insurance plan the cost of the insurance is basically absorbed by avoiding mutual fund management fees and otherwise payable income taxes. That being said if you do decide to use life insurance as an investment tool make sure that you are talking with a qualified advisor who fully understands not only its cost but also its potential.

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