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Term life insurance, which lacks a cash value, is not an investment
Whole life insurance and other types of cash value insurance can be considered investments
Because whole life insurance is complicated and expensive, it isn’t a good investment option for most life insurance shoppers
The main purpose of life insurance is to provide a financial safety net for your loved ones in the event that you die prematurely. That’s why a term life insurance policy, which is affordable and straightforward, is the right choice for most shoppers.
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. The cash value of a life insurance policy is a tax-deferred account that gains interest and grows over time. Because it works much like a traditional investment or savings account, some insurance companies and agents promote whole life policies as good investments.
But for most people, it’s best to think of life insurance as protection from risk rather than an investment that will make you money in the future.
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An investment is an asset that you purchase with the intention of selling at a profit in the future. Common investments include stocks, bonds, and real estate.
Term life insurance, which lacks a cash value, is not considered an asset or investment. It’s “pure” life insurance, meaning that you pay premiums to keep the policy active, and if you die during the policy’s term, your beneficiaries will receive the death benefit.
When you pay the premiums on a cash value life insurance policy, a certain percentage goes into the cash value, a tax-deferred account that grows at a rate determined by your insurer and what type of policy you have.
You can do many of the same things with cash value life insurance that you can with a traditional investment vehicle, including withdrawing money from it, or surrendering it and taking the cash. Depending on your policy, you may also be able to take out a low-interest loan against your cash value or use it to pay your premiums.
While whole life insurance might technically be an investment, there are several reasons why it’s usually not a very effective way to invest your money. Here’s why life insurance isn’t a good investment for most people:
Whole life insurance policies generally cost 5 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 most of the growth in your policy’s cash value happens when you’ve held the policy for two or three decades, if you surrender your policy within the first 10 years of owning it, it’s unlikely that your cash value will be greater than the total premiums you have paid.
On top of that, cash value life policies usually come with a number of hidden costs. These vary from insurer to insurer, but some typical fees and penalties you’re likely to encounter when you own a cash value policy include:
Cash value policies come with limited investment options and relatively low rates of return. Over the long run, dedicated investment vehicles—such as a mutual fund, 401(k), or IRA—will likely provide better returns than a whole life policy.
While some insurance companies advertise interest rates as high as 4% on whole life policies, keep in mind that those rates are often applied after the insurer takes out their fees, meaning that your cash value could grow at a slower rate than you expect.
That’s why for most people, it makes sense to save money by buying a much cheaper term life policy and direct the money they’ve saved into a more traditional investment that offers a higher rate of return.
Though a term life policy is the right choice for the majority of life insurance shoppers, there are a few instances in which using a cash value life 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 $11.4 million are subject to an estate tax. But the death benefit of a life insurance policy is tax-free, no matter the size of your estate. So, for example, if your estate was worth $13 million and you knew $1.6 of that would be subject to an estate tax, you might choose to take out a permanent life insurance policy worth $1.6 million so that money could go to your heirs free of tax when you die.
A permanent life 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 help 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, such as their 401(k) and IRA, might want an additional vehicle for tax-deferred savings. In these cases, a cash value policy could make sense, particularly if you also need life insurance coverage and can afford the high cost of premiums for a cash value policy.
It's best to consult with a financial advisor 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. By designating the trust as the beneficiary of a permanent life insurance policy, parents can ensure financial protection for their dependents.
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