More on Life Insurance
More on Life Insurance
Updated November 2, 2020|4 min read
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When people talk about using life insurance as an investment, they’re talking about whole life insurance and other types of permanent life insurance that have a cash value component. Cash value life insurance includes a tax-deferred savings account that gains interest and grows over time.
A term life insurance policy, which lacks a cash value component, is not considered an asset or investment. You pay a premium to keep the policy active, and if you die during the policy’s term, your beneficiaries receive a death benefit.
But, permanent policies are much more expensive than term policies, and the cash value can grow slowly. For most people, buying a more affordable and straightforward term policy and contributing to a standalone investment account is the best choice.
You can invest using whole life and other types of cash value life insurance, but not term life insurance
Because whole life insurance is complicated and expensive, it isn’t a good investment option for most people
If you need a permanent policy, your assets exceed the estate tax, or you’ve exhausted other investing options, then you may benefit from investing with your life insurance
You will likely see higher returns through traditional investments like a 401(k) or IRA
While permanent life insurance can be treated as an investment, the high cost of cash value policies and their associated fees and penalties means it’s usually not an effective way to grow your money.
For most people, purchasing whole life and other types of permanent life insurance isn’t a good way to invest. Whole life insurance policies cost an average of five to 15 times more than comparable term life policies, which means that they’re expensive to maintain over the long term. As a result, 45% of policies are dropped within 10 years of being purchased.
Since, like most investments, most of the growth in your policy’s cash value happens after you’ve held the policy for decades, surrendering your policy within the first 10 years makes it unlikely that your cash value will be greater than the total premiums you have paid into it.
Cash value policies also come with several hidden costs. These vary from insurer to insurer, but typical fees and penalties for a cash value policy include:
Administrative fees and operating expenses taken out by the insurer
A reduction in the policy’s death benefit when you withdraw from the cash value
A policy lapse if you completely deplete your cash value
Significant fees if you withdraw from the cash value during the surrender period
Possible forfeiture of the entire cash value if you cancel your policy during the surrender period
In comparison, term life insurance is more affordable for similar coverage amounts and does not involve fees or penalties for canceling the policy. And the rate of growth on whole life policies is often lower than that of a traditional investment account like a 401(k) or IRA.
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Though a term life policy is the right choice for the majority of life insurance shoppers, there are a few specific instances in which using a cash value life insurance policy as an investment might make sense:
If your heirs will have to pay an estate tax on your assets when you die, a permanent life insurance policy can help offset some of those costs.
In 2020, any assets above $11.58 million are subject to an estate tax. But the death benefit of a life insurance policy is tax-free, as long as it pays out to a beneficiary, rather than your estate. So, for example, if your estate is worth $13 million and $1.42 million of that is subject to an estate tax, you might take out a permanent life insurance policy worth $1.42 million so that money goes to your heirs — tax-free — when you die.
A permanent life insurance policy might also benefit your heirs if your estate consists largely of fixed or long-term assets, such as real estate. Your heirs will need to pay federal taxes on your estate within nine months of your death, which could be difficult if your assets aren’t liquid. A life insurance policy with a death benefit large enough to cover the taxes your family will owe can ease that financial burden.
For the same reasons that cash value life insurance isn’t a great investment, relying on cash value to supplement retirement income — a strategy sometimes called a life insurance retirement plan (LIRP) — isn’t recommended for most people.
But high-income earners who have already maxed out their other retirement accounts might want an additional vehicle for tax-deferred savings. In these cases, a cash value policy could make sense if you also need life insurance coverage and can afford the high premiums of a cash value policy.
Consult with a financial adviser who can walk you through the specifics of incorporating a life insurance plan into your retirement strategy.
People with lifelong dependents, such as children with disabilities, may want permanent life insurance coverage.
A parent with a lifelong dependent can set up a special needs trust, which is specifically designed for life insurance and estate beneficiaries who are unable to handle their own finances and care. Designating the trust as the beneficiary of a permanent life insurance policy ensures financial protection for their dependents.
While there are some situations in which you could benefit from investing in your life insurance, cash value policies come with limited investment options and relatively low rates of return. Over the long run, buying term life insurance at a lower cost and using dedicated investment vehicles — such as a mutual fund, 401(k), or IRA — will likely provide better returns than investing the cash value of a whole life policy.
Life insurance is not the smartest investment for most people. Cash value life insurance is more expensive than term life insurance and typically provides less return on your investment than a standalone investment account.
Term life insurance does not come with a cash value and therefore you cannot invest in a term policy. You may only invest in permanent life insurance with a cash value amount.
If you regularly contribute the maximum amount to your retirement accounts, your estate will be taxed, or if you have a lifelong dependent who would benefit from your permanent policy, then you might benefit from investing in life insurance.
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