Should you use consider life insurance as an investment? Short answer: probably no. However, there are exceptions. We’ll do a quick overview of the ways life insurance could be used as part of an investing strategy. We’ll mention the pros and cons of standard tactics, and discuss who these are best suited for. For those who want a fast answer, “Buy term life insurance and invest the difference” is a pretty good maxim for many people. We’ll explain why this is the case below.
The Difference Between Term and Permanent Life Insurance
Though there are many differences, and many policy variations on each, term and whole life insurance have one main difference: Term insurance covers a set number of years for a little amount of money; whole life insurance costs much more but provides coverage for a person’s entire life.
Term insurance is kind of like auto insurance in the sense that, you’re not sure if you’ll ever need to file a claim, but if you do, you’re sure glad you have it. But in this case, the huge potential payoff is for your family. Let’s say you are a young person, healthy, 35 years old with a husband and two children. You decide to buy a 20-year, $500,000 term life policy. It could cost you about $25 per month. If in that 20 years, you die for whatever reason, the insurer will pay your family $500,000.
Permanent life insurance includes two primary forms: whole and universal. For one, it’s much more expensive. At the same age and health mentioned above, you would probably pay about $500 per month for a $500,000 policy. One important difference, though, is that permanent insurance has a cash value component. The money you pay starts to accumulate a cash value that you can borrow against, as well as other options. Loans and withdrawals will impact death benefit value, however, along with reducing cash value and increasing the chance of lapsing the policy. Cash value starts out as a small percentage of the paid amount, but as your policy matures, it acquires more value which some people may start to use toward their high monthly premium payment Note, however, that premiums continue to be due for payment when using cash value in this way.
Life Insurance As An Investment? The Pros and Cons
While the primary purpose of whole life insurance is to meet the need for a death benefit and offer protection, it also holds possibilities for those who have maxed out other tax-advantaged retirement accounts or are looking to diversify their assets.
Most permanent life insurance policies, unlike investments, also offer a guarantee. The premiums you pay and the minimum rate of interest on the cash value accumulation is often guaranteed, although, many people say the return can be very small. As with investing, accumulation is subject to economic times and interest rates.
Additionally, you can take out non-taxable loans against a permanent life insurance policy (although it will affect the death benefit value). The death benefit paid when you die beneficiaries is also non-taxable. However, loans can result in a tax liability if the policy terminates before you die.
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As mentioned above, permanent life insurance policies cost much more than a term life insurance policy. That’s because a significant amount of the premium is used to cover that cash value accumulation component. Many could argue that the money saved from purchasing a term life insurance policy versus a permanent one, could see better returns if invested elsewhere.
Additionally, not all permanent policies offer a guaranteed return, which if you were purchasing one, would be a substantial benefit. Make sure you’re reading the fine print and any exclusions the policy may have for those guarantees.
Permanent life insurance isn’t a bad option as part of your financial plan. For some, it can offer a good opportunity to diversify.
However, for most people, term life insurance is a good, affordable option. You have the necessary coverage for your family, and you can invest the money you saved on premiums when compared to a permanent policy into investment opportunities that might have the potential for higher returns.
Term life insurance is also far less complicated, and you don’t need to work with a financial professional or agent to purchase the policy if you prefer not to. Some companies offer an entirely online process. You pick an amount and term length that fits your financial situation, and once approved, you pay the monthly premium, and you’re covered. Simple as that.