If you own or intend to own bonds or a bond fund for estate liquidity, you would be well advised to seek out participating life insurance as an alternative.
The investment side
- Life insurance companies buy huge chunks of government and corporate bonds. Similar to an individual but much cheaper than a fund.
- They also own high grade private issues and mortgages to which most investors have no access.
- They own a few high grade equity positions and some commercial real estate.
The insurance side.
Mortality is based on a table that results from the study of millions of lives over a long time. If you are unfortunate and die to soon, your estate will reap a huge financial reward.
If you are fortunate and live longer than average you will still win compared to a bond portfolio. I can hear the question, “I had to pay for insurance all along, so how can that work?” Because of several factors that you have no ability to access otherwise.
- Life insurance is a tax preferred investment. You are essentially doing an income split with a low rate tax payer when you allow an insurer to earn interest income on your behalf.
- Life insurers have very low costs to manage fixed income portfolios.
- Life insurers build contracts in such a way that there is a “lapse factor.” People who stay in a long time gain because those who quit early lose some of their investment.
- Participating life insurance policies have the possibility of a mortality gain. If people, in general, live longer, there will be fewer and later claims, and the assets in the pool will grow more quickly. A bit like investing indirectly in the healthcare and biotech industries.
The combination of insurance factors and investment factors makes for a fixed income heavy balanced fund with a very low ME, tax preferences, and almost no variability.
The early deceased person will end up with returns well over 10% after tax. Those who live past life expectancy will still be looking at returns in the 4% after tax range. Easily half again more than a bond fund.
The returns fluctuate with interest just like your bond fund. Higher future rates will make for higher participating insurance returns.
These plans are frequently used for estate income tax and other estate liquidity problems. The are an attractive alternate investment. Cheaper to run and easier to acquire than a hedge fund.
Every plan depends on client circumstances, but careful design frees significant amounts of money for other purposes. Do not put off the decision, declining health in future years could make the result unavailable.
More money makes for better security, easier estate resolution and more effective succession. Act soon.
Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.