Life insurance is something you can add to your financial plan if you want to provide some security for your loved ones. The proceeds from a life insurance policy can be used to pay for final expenses, pay off outstanding debts, or cover everyday expenses. Whether life insurance is a wise investment may depend on what you need and what you want the policy to help you with.
Key takeaways
- The investment part of permanent life insurance accumulates tax-free. You can also borrow against the cash value to buy a house or pay for your children’s tax-free college tuition;
- Alternatively, with term life insurance, all of your benefits will move a death benefit for your recipients with no cash price and therefore no expense component. This means small premiums in exchange for a large death benefit;
- Term life insurance may make sense if you want to be insured for a certain period of time, while permanent life insurance may cover you for life;
- Whether life insurance is a good investment or not, depends on your length of coverage and on your own financial situation as well.
Types of life insurance
When deciding if life insurance is a great investment, it’s essential to understand the kinds of policies you can obtain.
There are several options for life insurance plans, but they usually fall into two categories: permanent and term.
Term life insurance is designed to cover you for a specific period of time, hence its name.
For example, you can purchase a policy for 20 or 30 years. These policies operate similarly to other types of insurance policies you might have, such as car insurance; you pay a premium every month, and if something bad happens in this case your early death-you get a benefit.
On the other hand, permanent life insurance comprises you for life as long as your premiums are paid.
Some permanent life insurance may also have an investment component that allows policyholders to accumulate cash value.
When you understand financial advisors and, more frequently than not, life insurance brokers advocate life insurance as an investment, they are committing to the cash value part of permanent life insurance and how to fund and borrow that money.
When deciding if life insurance is a good investment, it is important to understand what policies you can purchase. There are several options for life insurance plans, but they usually fall into two categories: permanent and term.
Term life insurance is designed to cover you for a specific period of time, hence its name. For example, you can purchase a policy for 20 or 30 years. These policies operate similarly to other types of insurance policies you might have, such as car insurance; you pay a premium every month, and if something bad happens in this case your early death-you gets a benefit.
A life insurance tip
Contributions for term life insurance are usually cheaper than for permanent life insurance.
Pros and Cons of Term Life Insurance
Term life insurance can be a good investment if you don’t want to leave your loved ones with the burden of paying off debt or other expenses. Here are some of the most important benefits of purchasing a term policy.
The upside: lower premiums
Term insurance tends to be cheaper than permanent life insurance.
That’s because the insurance company expects less risk. After all, you’re only insured for a certain period of time.
The younger and healthier you are when you buy a term policy, the lower your premiums are likely to be.
Tip
Term life insurance policies without exams may allow you to skip medical exams, but they may carry higher premiums.
Pros: Flexibility
One of the benefits of term life insurance is that you can choose how long you want to be insured. So if you think you only need life insurance for 10 or 20 years, you can choose a term that fits your needs.
This means you have predictability in estimating how much you will pay in premiums over the entire term. On the other hand, a permanent life policy would be more of a guessing game because there is no fixed end date.
Pros: Switching to permanent insurance
If you decide you want to extend your life insurance policy indefinitely, you can convert it to permanent life insurance. This can increase your premiums, but it can be a worthwhile investment if you want lifetime coverage. Conversion can also give you the ability to accumulate cash value.
Cons of term life insurance
When you buy a term policy, all of your premiums go toward providing death benefits for your beneficiaries. Term life insurance, unlike permanent life insurance, has no cash value and therefore no investment component. If you are still alive when the term expires, the policy will simply expire and you and your beneficiaries won’t see any money.
However, you can think of term life insurance as an investment in the sense that you pay relatively small premiums in exchange for peace of mind, knowing that if you die, your beneficiaries will receive a relatively large death benefit.
An example of term life insurance
A non-smoking 30-year-old woman in excellent health could get a 20-year policy with a $1 million death benefit for $480 a year.
If this woman dies at age 49 after paying premiums for 19 years, her beneficiaries would receive $1 million tax-free when she paid only $9,120.
Term life insurance provides an incomparable return on investment if your beneficiaries ever have to use it.
That maintained it provides negative ROI if you are with the bulk of policyholders whose beneficiaries never file a case.
In this example, you’ll pay a comparatively low cost for peace of mind and can praise the fact that you’re still alive.
An example of permanent life insurance
What if the same lady described earlier had bought whole life insurance instead?
For an entire life insurance policy from the same insurance company, she could expect to pay $9,370 per year. So, how much money would she make for this extra expense?
- In five years, the guaranteed cash value of the policy will be $19,880, and she will have paid $46,850 in premiums.
- After 10 years, the guaranteed cash value of the policy will be $65,630, and she will have paid $93,700 in premiums.
- After 20 years, the guaranteed cash value of the policy would be $181,630, and she would pay $187,400 in premiums.
But after 20 years, if she obtained the term life insurance for $480 a year and invested the difference of $8,890 at an average yearly return of 8%, she would hold $421,064 before taxes.
“Sure,” you’ll say, “but a whole life insurance policy insures its return. I’ve not insured an 8% interest on the exchange.”
That’s true. But even if the woman described above had put an extra $8,890 a year into a savings account with a 1% interest rate, after 20 years she would have $196,425, which is still more than the guaranteed cash value of the permanent policy of $181,630.
Pros and cons of permanent life insurance
There are many arguments for using permanent life insurance as an investment.
Nevertheless, several of these benefits are not uncommon to permanent life insurance.
You can often get them in other ways without paying the high management costs and agency commissions that are associated with permanent life insurance.
Here are some of the most extensively supported advantages of permanent life insurance.
The upside: tax-free growth
Permanent life insurance policies with an investment component allow you to grow your fortune tax-free.
This means you don’t pay taxes on any interest, dividends, or capital gains on the cash value component of your life insurance policy until you collect the proceeds.
This is similar to the tax benefits you get with some retirement accounts, including IRAs, 401 (k) s, and 403 (b) s. If you increase your contributions to these accounts year after year, investing in permanent life insurance for tax reasons may make sense.
The upside: lifetime coverage.
Another advertised benefit of permanent life insurance is that you don’t lose coverage after a certain number of years. A policy expires when you reach the end of your term, which for many policyholders is about 60 years, while permanent policies can cover you for life.
If you expect people to be financially dependent on you beyond the length of a typical policy term (such as a disabled child), this benefit may be attractive to you.
Plus: Borrowing against cash
If you need money to buy a house or pay for college, you can borrow against the cash value of a permanent life insurance policy.
Conversely, if you invest in a tax-advantaged retirement plan such as a 401(k) and want to use it for a purpose other than retirement, you may have to pay penalties. Also, some retirement plans, such as a 457 (b), make it difficult or even impossible to get money for that purpose.
Pros: accelerated benefits
You can get 25% to 100% of the death benefit on your permanent life insurance policy before you die if you develop a certain condition, such as a heart attack, stroke, invasive cancer, or terminal kidney failure.
The advantage of accelerated benefits, as they’re called, is that you can use them to pay medical bills and perhaps enjoy a better quality of life in your final months.
Important
Accelerated payments are not unique to permanent life insurance; some policy terms also offer them.
Cons of permanent life insurance
While permanent life insurance can bring several benefits, there are some potential drawbacks to keep in mind.
Cost is one of the most important. Compared to term life insurance policies, permanent life insurance may require you to pay higher premiums. If it turns out that you don’t need life insurance, you may be paying premiums unnecessarily.
Permanent life insurance may also have tax outcomes for you if your beneficiaries decide to drop the policy or pass away with an excellent loan.
And taking loans or accelerated payments may decrease the death benefit payable to your beneficiaries if you die.
Is life insurance a sound investment?
Using permanent life insurance as an investment may make sense for some wealthy individuals seeking to minimize inheritance taxes. But for the normal person, purchasing terms and investing for the difference is normally a better option.
Even if you buy life insurance primarily for investment purposes, it’s still important to research the best life insurance companies to make sure you’re getting the best policy possible.
