An asset may help you invest in your retirement. Is life insurance an asset? The answer is: sometimes.
Is a life insurance policy an asset?
Life insurance is meant to help you plan for the future by ensuring that your loved ones will be financially taken care of when you die. By paying out a large sum of money, called a death benefit, usually in the range of $250,000 to $1 million, life insurance provides coverage for expenses like mortgage payments, funeral costs, health care bills, and other necessities that your beneficiaries may not be able to cover without it.
It’s tempting to think of life insurance as an asset, because, like a traditional asset, life insurance provides cash to live off of as your family gets older. But it turns out that life insurance is more complex than that. Read on to learn why.
An asset is a resource that you invest money into with the hope of receiving a return on your investment. For the majority of Americans, the home they own is their only asset, and they can expect to make a profit on their home when they eventually sell it. But assets can also include financial instruments like securities (stocks and bonds), deposit accounts, intangible assets like intellectual property, and tangible assets like vehicles, precious metals and art. Cryptocurrency like bitcoin is also frequently considered an asset, as are investments in fiat currencies.
When you invest money in an asset, you’ll receive some kind of rate of return. Many people receive an income from the assets they own, whether it’s a real estate developer renting out buildings he owns or someone trading stock. Other people build up their assets so the money they generate will allow them to retire.
Strictly speaking, insurance is not an asset, because insurance is simply the transfer of risk. You shouldn’t want to use the insurance, because that means something terrible has happened to you, such as your untimely death. You pay an insurance carrier to accept the risk that you would have assumed instead, and in most cases, you don’t get anything in return if you don’t suffer the consequences of that risk while insured.
Low-risk people – people who are young, healthy, and don’t have any dangerous hobbies – pay lower premiums for insurance, while high-risk people – people who are older, have pre-existing medical conditions, and enjoy putting their life and limb in peril – pay more. If you have a term life insurance policy, that money doesn’t go into an investment account, but to the insurance company in exchange for protection against that risk, or what’s called insurance coverage.
Most people have term life insurance policies. With a term life insurance policy, you pay relatively low premiums for coverage as high as $500,000 to $1 million, and the policy remains in effect for the duration of the term, usually 10, 20, or 30 years. That’s a lot of money, but you should also hope the insurance company never pays out, because you’d be dead. With an asset, the whole point is to collect a lavish payout.
The great thing about term life insurance, however, is that it can complete your financial strategy. Your insurance premiums may cost you as low as $22 to $41 per month, depending on your age, coverage amount, and term length, so you’ll have plenty of cash left over after paying the premium to invest. Because assets may take decades to appreciate into their full value, you could die before your investment has matured, and your loved ones would benefit much more from the life insurance death benefit than from what you have stashed away. That’s why it’s a great idea to have both.
Some life insurance policies do function as an investment vehicle, where you may pay significantly higher premiums but some of the premium is invested in a fund. In this case, the policy can be considered an asset.
Such life insurance policies are called permanent life insurance policies, of which the most common is whole life insurance, and they have a cash-value component that grows the longer you hold the policy. Each time you pay your premiums, a percentage of the premium goes toward paying for the death benefit and a percentage goes into an interest-bearing savings account. Whole life insurance lasts your whole life and works great as a forced savings account, in that you’re obligated to keep investing in your savings in order to keep the account in effect.
Like a 401(k), investments into a cash-value fund are tax-deferred. The policy will still pay out a death benefit to your beneficiaries when you die, but over time this death benefit is gradually replaced by the cash value. Eventually, the cash value will represent the entirety of the death benefit; if you die while the policy is in force, your beneficiaries will receive the cash value.
The cash value earns interest. However, you’ll not only earn a lower rate of return than a dedicated investment vehicle but also pay additional expenses, such as policy administration expenses and underwriting costs. You can redeem the cash value from the policy by canceling or surrendering it, but you may pay a surrender fee as well as taxes and other fees.
Then why doesn’t everyone do this? Frankly, because the rate of return on a whole life insurance cash value is lower than simply investing the money in your retirement account. While some exchange-traded funds (ETFs) have rates of return as high as 12%, and even funds with lower interest rates will like still be a few points higher than the average interest rate on a cash value policy.
If you want to use a cash-value life insurance policy as an investment tool, you have options beyond whole life insurance, including variable life insurance and indexed universal life insurance. Permanent policies also cost more than a traditional term life insurance policy, with whole life being up to four times as expensive as term.
Although a permanent life insurance policy with a cash-value component will help you save for retirement, the best way to maximize your returns is to combine a term life insurance policy with a traditional savings account like a 401(k) or an IRA. There are several reasons for this.
For one, you pay much higher premiums to keep a whole life insurance policy in effect. In fact, you could be paying as much as a few hundred bucks per month for a whole life insurance policy, money which could be going toward maxing out your IRA contributions. With a term life insurance policy, you’ll be paying much less money for the same coverage.
You also don’t need as much coverage as you get older. Term life insurance is meant to cover you while you still have people who rely on your financial support. But whole life insurance covers you your whole life, even though after you retire you have fewer people who depend on you.
Combine an inexpensive term policy for the coverage you need, max out your retirement funds, and pocket more money in retirement.