Updated May 7, 2021|5 min read
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Whole life insurance and other types of permanent life insurance can be used as an investment vehicle. But if you’re looking for the highest returns, brokerage accounts, education accounts, and retirement savings plans – like IRAs and 401(k)s – offer more value for your money.
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 with cash value accounts 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 expensive and offers low returns, it isn’t a good investment option for most people
If you need permanent life insurance, 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. The cash value is a tax-deferred savings account that gains interest and grows over time, but every policy is different in how the cash can grow or shrink.
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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 more expensive to maintain over time than other investments. As a result, 45% of policies are surrendered 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 (or take a loan) 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 comparable 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.
Wondering if term life insurance or permanent life insurance is best for you? Below we compare the cost of traditional investing combined with a term life policy and using a permanent life insurance for retirement, also known as a life insurance retirement plan (LIRP).
Cost comparison, term life & traditional investing vs. LIRP
|TERM & 401(k)||TERM & ROTH IRA||PERMANENT & LIRP|
|Monthly premiums||$25.43||$25.43||$127.15-$381.45 (5-15x term)|
|Cost of retirement account||No minimum investment required||No minimum investment required, some brokers set a minimum initial investment||Cost of policy premiums|
|Maximum investment per year||$19,500 (+$6,500 if older than 50)||$6,000 (below age 50); $7,000 (age 50 & up)||None|
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:
People with particularly high net worths can benefit from permanent life insurance. 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.
As of 2021, any assets above $11.7 million are subject to an estate tax. However, 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 $1.3 million of that is subject to an estate tax, you might take out a permanent life insurance policy worth $1.3 million so that money goes directly 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 how to use life insurance in your retirement planning.
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.
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Using a permanent policy or annuity to supplement retirement income can make sense for people with more complex financial needs (as mentioned above) or people who know they’ll need life insurance coverage for the rest of their lives.
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.
Life insurance terminology doesn't have to be confusing. Here are definitions of the most common terms and phrases you'll find in a policy.
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