Everybody knows the basic idea of life insurance: Wage-earners spend a little bit each month to make sure that, if anything happens to them, their families can enjoy some degree of financial security. But what about affluent clients who are already financially secure? Do they have any use for life insurance?

For many well-to-do people, the answer is yes, experts say.

"Financial advisors tend to see life insurance as a potentially important long-term investment for their clients," says Michael A. Mingolelli, the CEO of Pinnacle Financial Group, an insurance and benefits consulting firm in Southborough, Mass.
"Generally speaking, it has three major advantages over many other types of investments: certainty, liquidity and favorable tax treatment."

Classic life insurance is a certain investment because of the death benefit (variable life insurance is less certain). Unlike equities, heavily regulated life insurance is guaranteed to pay out eventually, assuming you pay the premiums-an advantage that might not have sounded important a few years ago, but which is likely appreciated by those looking at their equity portfolio statements today.

The real question is not if classic life insurance will grow in value and pay out, but when and how much. Somewhat perversely, the sooner the insured person dies, the better the return on the investment. This is true even for the type of life insurance policies that tend to be used as an investment, namely "permanent" life insurance policies, which require the holders to pay relatively high premiums when the insured is young. Part of these premiums then becomes "cash value," which is eventually used to keep premiums in check when the person grows older (and would otherwise increase substantially). These internal cash values grow tax-free over the life of the policy and continue to remain free of income tax unless the owner makes substantial withdrawals during his life.

Life insurance is liquid because of the insurance company's obligation to pay the proceeds as soon as the claim is filed and because it generally avoids probate. Liquidity is an advantage in any environment, since cash can immediately buy things, and people in need of it otherwise have to sell assets for less-than-reasonable prices. And liquidity is a particularly great advantage for an estate. Without it, heirs are stuck trying to pay estate taxes by selling off substantial amounts of property, sometimes in a fire sale, since much of the decedent's wealth is likely not in cash but in stocks, bonds, real estate or other illiquid items. So having life insurance proceeds available to fund the purchase of these assets and then pay estate expenses can mean significant savings.

An inflow of insurance proceeds can also be quite useful to family-owned businesses. "It is not uncommon for parents to take one or two of their children into the business while the others pursue alternative careers," says Robert Morrill, an estate planner with Gilmore, Rees & Carlson P.C. in Wellesley, Mass. "The parents want to treat all their kids equally, but they don't think it is a good idea for some of their kids to own a big chunk of a business they don't know much about." These parents may have all their wealth tied up in their businesses, so they don't have enough assets for even distributions to the kids. If they use a life insurance component, however, they have a stream of cash to keep the estate distributions even.

Business owners overseeing closely held companies may also need liquidity to pass the business on to surviving partners. Even though a business owner may work well with his partner, he may not want to give that partner's heirs a say in the company when the partner dies. Instead, he can make an arrangement giving partners or fellow stockholders the right to purchase a deceased co-owner's share. In this strategy, either the company or the co-owners purchase a life insurance policy on every owner. If one of them dies, the surviving partner or partners become the sole owners and the deceased partner's heirs get paid for the value of their interest with life insurance proceeds. The biggest problem is valuing the shares, which can sometimes be difficult to do in a closely held company.

Since lawmakers consider insurance a hedge against catastrophic loss rather than an investment, it has tax advantages. That means all the cash value accumulated in a permanent life insurance policy grows free of income tax-even the cash in those policies that depart from the classic model and instead serve as a "wrapper" for equity investments.

"Wrapping can be especially useful for wealthy individuals who are involved in hedge funds," says Mingolelli, "because short-term trades don't benefit from low capital-gains rates."

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