If you are interested in providing a certain level of security for your loved ones, you can consider adding life insurance to your financial plan. The proceeds from a life insurance policy can be used to pay final expenses, eliminate outstanding debts, or pay daily expenses. Whether life insurance is a wise investment may depend on your needs and the policy you want to make for you.
- Whether life insurance is a good investment for you depends on your personal financial situation and the length of time you need to cover.
- If you want to be protected within a set period of time, term life insurance makes sense, while permanent life insurance can provide you with lifetime protection.
- The investment portion of permanent life insurance has grown tax-free. You can also borrow cash value to buy a house or pay for your children’s college expenses, tax-free.
- Or, for term life insurance, all your payments are used for the beneficiary’s death benefit, there is no cash value, and therefore no investment component; this means a small premium in exchange for a large death benefit.
Types of life insurance
When deciding whether life insurance is a good investment, it is important to understand the types of policies you can purchase. There are many variations of life insurance plans, but they are generally divided into two categories: permanent and regular.
Term life insurance is designed to provide you with coverage for a fixed period of time, hence the name. For example, you can purchase 20-year or 30-year term life insurance. The functions of these policies are similar to other types of insurance policies that you may carry, such as car insurance; you have to pay premiums every month, and if something bad happens—in this case, you die prematurely—there will be one Compensation.
On the other hand, permanent life insurance can provide you with lifetime protection as long as you pay the premium. Certain types of permanent life insurance can also include an investment component, allowing policyholders to accumulate cash value. When you hear about financial advisors, and more commonly, life insurance agents advocating life insurance as an investment, they are referring to the cash value portion of permanent life insurance and the ways in which you can invest and borrow this money.
Term life insurance premiums are usually cheaper than permanent life insurance premiums.
Pros and cons of permanent life insurance
There are many arguments to support the use of permanent life insurance as an investment. However, many of these benefits are not unique to permanent life insurance. You can usually get them in other ways without having to pay the high management fees and agency commissions that permanent life insurance brings. Here are some of the most widely promoted benefits of permanent life insurance.
Advantages: tax deferred growth
A permanent life insurance policy with an investment component allows you to increase your wealth on the basis of deferred taxes. This means that you do not need to pay taxes on any interest, dividends, or capital gains on the cash value portion of the life insurance policy before you withdraw the income. This is similar to the tax benefits you get through certain retirement accounts, including IRAs, 401(k)s, and 403(b)s. If you maximize your contributions to these accounts year after year, it may make sense to invest in permanent life insurance for tax reasons.
Advantages: lifetime coverage
Another touted benefit of permanent life insurance is that you will not lose insurance after a certain number of years. When your tenure ends, the term insurance policy will end. For many policyholders, they are in their 60s, and a perpetual insurance policy can provide you with lifetime protection. If you expect that people will be financially dependent on you for longer than a typical policy term (for example, children with disabilities), then this benefit may be attractive to you.
Advantages: borrowing at cash value
If you need money to buy a house or pay for college expenses, you can borrow with the cash value of a permanent life insurance policy. Conversely, if you put money into a tax-friendly retirement plan such as a 401(k) and want to take it out for purposes other than retirement, you may have to pay a fine.In addition, some retirement plans, such as 457(b), make it difficult or even impossible to withdraw funds for such purposes.of
Advantages: accelerated revenue
If you have certain diseases such as heart disease, stroke, invasive cancer, or end-stage renal failure, you may be able to receive a death benefit from 25% to 100% of permanent life insurance before you die. The benefit of the so-called accelerated benefits is that you can use them to pay for medical expenses and possibly enjoy a better quality of life in the last few months.
Accelerated benefits are not unique to permanent life insurance; some term policies also provide them.
Disadvantages of permanent life insurance
Although permanent life insurance can bring many benefits, there are some potential disadvantages to keep in mind. Cost is one of the most important factors. Compared with term life insurance policies, permanent life insurance may require you to pay higher premiums. If it turns out that you do not need lifetime insurance, you may pay premiums unnecessarily.
If your beneficiary decides to give up the policy or dies due to outstanding loans, permanent life insurance may also have tax implications for you. Getting a loan or accelerated benefit may reduce the death benefit paid to your beneficiary when you die.
Pros and cons of term life insurance
If you don’t want your loved ones to bear the burden of repaying debts or other expenses, term life insurance may be a good investment. Here are some of the most important benefits of buying term life insurance.
Advantages: lower premiums
Compared with permanent life insurance, the purchase cost of term life insurance is usually lower. That’s because the insurance company takes less risk, because you only insure for a set period of time. When you buy a term life insurance policy, the younger and healthier you are, the lower your premiums may be.
One of the advantages of term life insurance is that you can choose when you want to insure. Therefore, if you think you only need 10-year or 20-year life insurance, you can choose a term that meets your needs. This means you can predict how much premiums you will pay throughout the term. On the other hand, permanent life insurance is more like a guessing game because there is no fixed end date.
Advantages: Convert to permanent insurance
If you decide to extend term life insurance indefinitely, you can convert it to permanent life insurance. Doing so may increase your premiums, but if you want lifetime protection, it may be a worthwhile investment. Conversion can also give you the opportunity to accumulate cash value.
Disadvantages of term life insurance
When you buy a term insurance policy, all your premiums will be used to ensure death compensation for your beneficiaries. Unlike permanent life insurance, term life insurance has no cash value and therefore no investment component. If you are alive at the end of the term, the policy will lapse and you and your beneficiaries will not see any money.
However, you can think of term life insurance as an investment because you pay relatively small premiums in exchange for peace of mind, because you know that if you die, the beneficiary will receive a relatively large death benefit.
If you are interested in a fixed-term insurance policy that has a built-in savings mechanism that can reward your payments in the future, a premium return (ROP) life insurance policy may be an attractive option. You will pay a flat rate during the validity period of the policy, but unlike traditional term life insurance, you will get all the money back at the end of the term.
Example of term life insurance
A healthy, non-smoker 30-year-old woman may be able to get a 20-year policy and a death benefit of $1 million at a price of $480 per year. If this woman died at the age of 49 after paying premiums for 19 years, her beneficiary would only have to pay US$9,120 to receive a tax-free income of US$1 million.
If your beneficiary has to use term life insurance, it can provide an unparalleled return on investment. That being said, if you are one of the majority of policyholders whose beneficiaries have never filed a claim, it will provide a negative return on investment. In this case, you will pay a relatively low price for peace of mind, and you can celebrate the fact that you are still alive.
Example of permanent life insurance
What if the same lady mentioned above purchases permanent life insurance? For a whole life insurance policy from the same insurance company, she expects to pay $9,370 per year. So, how much cash value will she accumulate for this additional expense?
- After five years, the guaranteed cash value of the policy is US$19,880, and she will pay US$46,850 in premiums.
- After 10 years, the guaranteed cash value of the policy is $65,630, and she will pay a premium of $93,700.
- After 20 years, the guaranteed cash value of the policy is US$181,630, and she will pay a premium of US$187,400.
But 20 years later, if she buys a term loan at a price of US$480 per year and invests it at a price difference of US$8,890, with an average annual return of 8%, then her pre-tax income is US$421,064.
“Of course,” you said, “but a whole life insurance policy guarantees its return. I cannot guarantee an 8% return in the market.” This is true. However, even if the above woman deposits an additional $8,890 into a savings account with an interest rate of 1% each year, she will still have $196,425 after 20 years, which is still higher than the guaranteed cash value of the perpetual policy of $181,630.
Is life insurance a wise investment?
For some high-net-worth individuals who want to minimize inheritance taxes, it may make sense to use permanent life insurance as an investment. But for ordinary people, the purchase period and the investment price difference are usually a better choice.
Even if you buy life insurance primarily for investment purposes, it is still important to research the best life insurance companies to ensure you get the most profitable policy.