Life Insurance: An Investment Or A Safety Net?

Life insurance is a complex topic that has financial advisors and insurance professionals debating. While life insurance is primarily designed to pay a death benefit to your beneficiaries, it can also be used as an investment vehicle. Permanent life insurance policies, such as whole life insurance, offer a cash value component that grows over time and can be borrowed against or withdrawn. This makes it a form of forced savings, providing guaranteed returns and tax advantages. However, permanent life insurance tends to be much more expensive than term life insurance, with higher premiums that may not be worth it for most individuals. Term life insurance, on the other hand, is generally more affordable and provides coverage for a set period. When deciding whether to invest in life insurance, it's essential to consider your financial situation, the duration of coverage needed, and the potential returns compared to other investment options.

Permanent life insurance policies can be used as an investment

There are two main types of permanent life insurance that can be used as an asset: whole life insurance and universal life insurance.

Whole life insurance

Whole life insurance is the most common type of permanent life insurance, which, in addition to a death benefit, offers the policyholder the ability to accumulate cash value. This works because a portion of the premium you’ll pay every month gets put into a cash value account. Think of it as an insurance policy with a saving account-like component. Your cash value will accumulate over time at a minimum guaranteed rate indicated by your policy. Just make sure you read the fine print of your policy to understand what that is. Also noteworthy, the premiums on these policies typically won’t increase over the life of the policy.

Universal life insurance

Universal life policies function similarly to whole life – they allow policyholders to grow an asset by accruing interest over time that can be borrowed against. Keep in mind that, with universal life policies, the premiums aren’t set, which means they are subject to change, and there’s also no guarantee on the rate your money will earn over time. Under the universal life umbrella is something called “variable universal life insurance,” which enables policy owners to invest their earnings into the accounts of their choosing (including mutual funds), so you have the potential to earn more over time.

Variable universal life insurance

With this type of permanent life insurance plan, you can invest your cash value into different kinds of funds and indexes of your choosing. Like universal life insurance, you can adjust your premiums and death benefit.

Indexed universal life insurance

Indexed universal life insurance also allows you to invest the cash value component, which can grow based on stock performance. This type of plan offers flexible coverage that will last your lifetime.

Using permanent life insurance as an investment

• Get a life insurance policy loan: Once you have sufficient cash value, you can get a loan from your life insurance policy using the cash value as collateral. With a policy loan, you can pay back what you owe at your own pace. But if the loan amount exceeds your cash value, your policy may lapse.
• Withdraw funds from your policy: The cash value component also allows you to withdraw funds from your life insurance policy. You can use these funds to cover any expenses. Keep in mind that withdrawing from your cash value will reduce the death benefit.
• Supplement your retirement income: If you save up enough cash value, you can add it to your retirement portfolio and use the funds to supplement retirement income. Consider growing your cash value for several years before tapping into the funds to grow your nest egg.

Term life insurance is a more affordable option

Term life insurance premiums are based on a person's age, health, and life expectancy, among other factors. The insurance company will consider the policyholder's age, gender, driving record, medical history, and other factors to determine the premium. While term life insurance premiums increase with age, they are generally more affordable than permanent life insurance premiums, especially for younger individuals.

Term life insurance also offers flexibility in terms of coverage amounts and term lengths. Policyholders can choose from a range of term lengths, such as 10, 15, 20, or 30 years, and can often renew their policies for additional terms. Additionally, term life insurance policies can be converted to permanent coverage, providing long-term financial security.

When compared to permanent life insurance, term life insurance has several advantages. It is a good option for young, healthy individuals or families who want substantial coverage at a low cost. Term life insurance can provide peace of mind and financial protection during specific periods of financial vulnerability, such as raising a family or paying off a mortgage.

However, it is important to consider the limitations of term life insurance. If the policyholder outlives the term, there is no payout, and the premiums paid are not returned. Additionally, term life insurance may not be suitable for those seeking long-term financial security or investment opportunities. In such cases, permanent life insurance, despite its higher costs, may be a more suitable option.

Permanent life insurance has high costs and low returns

Permanent life insurance policies, such as whole and universal life insurance, offer lifelong coverage and typically have a cash value component that grows over time. However, permanent life insurance has high costs and low returns. The rates for permanent life insurance are significantly higher than those for term life insurance. For example, a healthy 40-year-old man can expect to pay an average annual premium of $7,440 for a $500,000 permanent life insurance policy, while the average annual premium for a term life insurance policy with similar coverage is only $334.

The high cost of permanent life insurance is due to the lifelong coverage and investment opportunities it provides. These policies typically last your entire life and allow you to build cash value that you can borrow against or withdraw from. The cash value component is similar to an investment account and grows at a rate specified by the policy. However, the cash value tends to grow slowly, and it can take 10 to 15 years or longer for it to build up enough to be useful.

In addition to high costs, permanent life insurance also offers low returns compared to other investment options. The average annual rate of return on the cash value for whole life insurance is between 1% and 3.5%. In comparison, other investments such as stocks, bonds, and real estate may provide higher returns. As a result, permanent life insurance may not be the best investment strategy for most people. Buying a term life insurance policy and investing in standalone investment accounts like a 401(k) or IRA may be a better option for those looking to protect their loved ones financially and invest for retirement.

While permanent life insurance has high costs and low returns, it may still be a good option for some individuals. For example, those who need lifelong coverage, want to use life insurance to leave an inheritance, or have complex financial needs may find permanent life insurance worthwhile. Additionally, permanent life insurance can provide tax benefits, such as tax-deferred growth of the cash value and a tax-free death benefit for beneficiaries.

Permanent life insurance is beneficial for high-net-worth individuals

Permanent life insurance provides high-net-worth individuals with the assurance that their coverage will remain in force for life, as long as policy conditions are met. The cash value feature of permanent policies offers a low-risk investment opportunity with predictable returns, which is attractive to those with ample savings. Additionally, permanent life insurance can provide dividend earnings and the potential for higher returns compared to other investment options.

For high-net-worth individuals with complex financial needs, permanent life insurance serves as a valuable tool for estate planning and charitable giving. The death benefit can be used to cover estate taxes, ensuring that beneficiaries receive their full inheritance. It can also provide tax benefits by naming a charitable organization as the beneficiary, allowing individuals to make donations upon their death and potentially reducing their taxable income.

While permanent life insurance is more expensive than term life insurance, it offers high-net-worth individuals a range of advantages, including lifelong coverage, cash value accumulation, and potential dividend earnings. By accumulating cash value, permanent life insurance policies provide a source of tax-deferred growth, making them a useful supplement to retirement income.

Permanent life insurance is ideal for those with lifelong dependents

Permanent life insurance is particularly beneficial for those with lifelong dependents, such as children with disabilities, as it ensures their dependents always have a financial safety net. A parent with a lifelong dependent can set up a supplemental needs trust, which is specifically designed for life insurance and estate beneficiaries who are unable to handle their finances and care. By designating the trust as the beneficiary of a permanent life insurance policy, financial protection for their dependents is ensured.

The two primary types of permanent life insurance are whole life and universal life. Whole life insurance offers a guaranteed growth rate for the cash value of the policy, while universal life insurance provides more flexible premium options and bases its earnings on market interest rates. Variable life and variable universal life insurance offer expanded investment options, allowing the cash value to be invested in mutual funds and other financial instruments.

While permanent life insurance is more costly than term life insurance, it can be a valuable investment for those with lifelong dependents, providing ongoing coverage and savings opportunities.

Frequently asked questions