The Role of Life Insurance in an Asset Location Strategy
Asset Allocation has been part of the investment professional’s asset management strategy for decades. More recently, a considerable amount of attention has been focused on a natural extension of that approach: Asset Location.
While the two terms are extremely similar, their meaning is quite different:
- Asset Allocation: The selection of a diversified portfolio of stocks, bonds, cash and alternatives aligned with an investor’s time horizon and risk tolerance.
- Asset Location: The placement of assets in taxable, tax-deferred and tax-free accounts with the goal of minimizing taxes
Where is Asset Location Being Talked About?
A quick Google search uncovers any number of hits from asset managers and the like, but if we look at where most consumers may ultimately go for information on a topic like this once they are exposed to it, two sources stand out:
- Investopedia: Minimize Taxes With Asset Location
- Fidelity: Are you invested in the right kind of accounts? See how tax-smart asset location can potentially help improve after-tax returns.
Fidelity goes so far as to outline the tax treatment of various assets as part of their effort to educate their clients as seen in Figure 1.
The insurance professional will notice one very important omission in both of those articles and Figure 1: Both Fidelity and Investopedia have neglected an asset class that should play a large role in the Asset Location conversation: Cash Value Life Insurance. This omission is not just common, it’s nearly universal. The asset management community largely has no idea how life insurance fits in this approach they have already embraced and are using with their clients.
The life insurance community has known for years that life insurance’s unique value proposition positions it as an analog to things like Roth IRAs that have the following characteristics regarding taxation:
Tax-free: Will be invested after tax, but you will not pay taxes on any distributions from these assets.
Of course, life insurance has a significant advantage: The income-based limitations that can prevent clients from utilizing Roth IRAs don’t exist for life insurance.
If we investigate the account types that fall into the tax-free category further, as seen in Figure 2, the advantages of life insurance over alternatives becomes even more clear:
What’s the Bottom Line?
In short, positioning cash value life insurance as a tax-free asset in an asset location strategy is an ideal way to introduce the investment community to life insurance. It places life insurance in a context they are already comfortable with and solves a challenge they face in terms of income-based limitations and the like that can prevent their clients from utilizing more traditional tax-free assets that offer market returns.
Educating both current and prospective advisors on this topic is an obvious next step. Accomplishing that requires not only building awareness of the role life insurance can play in this strategy, but also how to actually go about implementing it with a real client.
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The contents of this document should not be considered as tax or legal advice. Any information or guidance provided is solely for educational or informational purposes and should not be relied upon as a substitute for professional advice. It is always recommended to consult with a licensed financial or legal advisor for specific guidance related to your individual situation.