Updated Dec. 19, 2019: You may have heard that life insurance is not an investment.
And yet there are some experts out there say that life insurance is a good investment. What gives?
Anyone talking about using life insurance as an investment is talking about a permanent life insurance policy, most likely a whole life insurance policy. Whole life insurance differs from term life insurance in two major ways: it doesn’t expire, and it has a cash value portion. Here's a comparison of whole life insurance and term life insurance.
The latter is where the investment aspect comes in.
When you pay your premium for a whole life insurance policy, part of that goes to the life insurance policy, and part of it goes to an interest-earning investment that goes up in value just like any other long term investment you’d make. Because you’re essentially using your premium to both pay for your insurance and fund the investment part of the policy, and because the policy lasts well into your golden years (when you’re more expensive to insure), whole life insurance is a lot more expensive than term.
If you're still confused, check out this explainer on the different types of life insurance policies.
Why do some experts still recommend it?
Because people are bad with money, especially in the long term. Most either don’t invest or, if they do, they make poor investment choices. By using whole life insurance as an investment, consumers can essentially kill two birds with one stone: they get life insurance, which is important, and they also have investment taken care of for them, which is also important.
So some experts recommend life insurance as an investment strategy because it forces investing.
But it still may not be worth it.
The money in the cash value portion of your whole life insurance policy is tax-deferred, meaning you don’t pay taxes on it until you withdraw it, but many other investment vehicles (like 401(k)s and traditional IRAs) also offer this option.
You can borrow against the cash value portion to pay for big expenses without any withdrawal penalties, unlike most retirement products, which have penalties if you withdraw before you reach a certain age. But you’ll be charged on your cash value withdrawal until you repay it, erasing the gains you’ve made and making it an undesirable option. (You can learn more here.)
Plus, the return you’ll get just isn’t all that great. Administrative fees for a whole life insurance policy cash value amount are high compared to other investment options, and you may not have any control over how you’re investing. You can also drain your cash value to pay for your insurance premium when you get older, if you aren't making the same income you did when you bought the policy and can no longer afford the monthly payments.
You might be thinking that despite all the negatives, the important thing is you’ll at least have the insurance option when you’re old, but it’s honestly not necessary for most people. Life insurance is a valuable income replacement option if you die and your family still has a mortgage, college, and other big expenses to worry about. When you’re in your 50s, 60s, and 70s, you don’t have as many of these expenses, so you’re paying for protection that has no practical use.
Overall, life insurance is not a good investment because whole life insurance is not a good option. Policygenius can help you find affordable life insurance here.
So, what’s the better alternative?
First, get a term life insurance policy that provides the coverage your family needs while still being affordable.
The next step is a little harder. Remember how people are bad at investing? It’s important to educate them so it can be better. Nowadays, it’s not too hard to save money. Automate investing in workplace 401(k)s and IRAs. Use low-fee index funds at places like Vanguard for a simple, cheap way to invest. Heck, use an app like Acorns or Stash to save even more money. Here's our review of these popular investing apps.
In the end, "buy term and invest the difference" is still the best option for most people. Using life insurance as an investment gets you a mediocre life insurance product and a mediocre investment product. A little education about better investment options can go a long way in making better investment choices.
Not sure where to start? Learn more about investing here.