Is Life Insurance A Smart Investment? How To Make The Most Of Your Insurance
While there's no way of knowing what happens after we die, there are ways you can make things easier for those you leave behind. One of the best solutions is life insurance, which provides your family with a cash benefit when you die.
With it, you give those who depend on you – your spouse, kids, or parents – with the means to stay afloat as they grieve. However, there’s a trade-off. To maintain a policy, you have to pay monthly premiums that could otherwise go to food, bills, and luxuries you can enjoy while you're still alive.
So is it a good idea to actually invest money into an insurance policy? In this guide, we’ll discuss five reasons you should look at life insurance as an investment and three instances where life insurance may NOT be the right choice for you.
Defining Life Insurance
Before we talk about what makes life insurance a good investment, we'll define some important terms first.
Life insurance is a contract between an insurance provider and a policyholder which states that, upon the latter's death, the former will provide their beneficiaries with an agreed-upon lump sum.
This lump sum is called a death benefit and can be used by the policyholder's beneficiaries to cover things like funeral expenses, medical bills, tuition, credit cards, debts, and anything else. In exchange for coverage, policyholders are charged a fee, called a premium. Paying premiums can be done monthly, annually, semi-annually, or quarterly.
There are many different types of life insurance policies:
Term life insurance: Term life insurance only lasts for a specific amount of time, with terms ranging between 5 and 20 years. Some long-term policies can last up to 30 years. Once your term insurance is up, you can choose to convert your plan to a whole life policy or start a new term life insurance policy.
Whole life insurance: Also called permanent life insurance, whole life insurance provides policyholders with lifelong coverage and an investment component, called a cash value. With a cash value account, you can save money and allow it to accrue interest over time. However, this comes at a cost – according to Business Insider, whole life insurance can be six to 10 times more expensive than term life insurance.
Universal life insurance: Universal life insurance is another type of permanent life insurance. It's similar to whole life insurance in a lot of ways, except for the fact that the premiums and death benefit can be adjusted. If you're a freelancer or someone with an unpredictable income stream, this may be the best life insurance option for you.
Other types: There are several other types of life insurance policies, such as variable life insurance and final expense insurance.
5 Ways Life Insurance Can Be A Good Investment
Now that you're more or less familiar with the terms, let’s talk about some of the ways in which life insurance may be a good investment option:
1. Life Insurance Can Become An Income Replacement
Most people buy life insurance to provide their families with enough money to stay afloat when they're gone. This financial security comes in the form of the death benefit, which is often provided as a one-time lump sum. In certain cases, this is a good thing – some families need to pay for big expenses such as hospital bills, student loans, credit cards, funeral expenses, and debts.
But if you already have a final expense plan or have paid for these things before your death, your beneficiaries can also choose to budget the cash benefit to act as a replacement for your income. This is especially helpful if you're the sole breadwinner of the family or if you make significant contributions to your household. In this way, your family won't feel the financial burden of losing your income stream.
The best life insurance companies have life policies that allow beneficiaries to receive the benefit as an annuity. This means that they will receive the amount on a monthly basis instead of a lump sum. This is good for people who may find it difficult to handle and budget such a large sum.
2. You Can Use Life Insurance To Pay Off Debts
Universal life and whole life insurance both come with a cash value component. Cash value insurance is that users get to reap the benefits of their policy while they're still alive.
Usually, life insurance companies allow their policyholders to borrow against or loan from their policies. Once you have built up your cash value, you can borrow or take money from the account and use it for any purpose, including student loans, credit cards, car insurance, or even simply fund a holiday.
Unlike with personal loans, the best-case scenario is that you don't have to pay back your loan at all. However, do take note that your loan could accrue interest. If you don't pay it back, the insurance company can deduct the loaned amount from your cash value or death benefit.
3. You Can Use Your Insurance To Save For Long-Term Goals
What makes universal life insurance a unique and worthwhile investment option is the fact that you can adjust your premium payments and death benefits.
Universal policies have a minimum and maximum premium. Once you pay the cost of insurance (COI), you can pay in excess (within the limit) to grow your cash value. So if you're looking to save up for something in the distant future – say a mortgage, your kid's tuition, or a new car – you can pay more in premiums. When you need the money, just borrow against your policy like you would with a whole life insurance policy.
Variable life insurance also allows you to invest in varying investment options like equities, mutual funds, bonds, and property. You can control how much risk you want to take on and grow your money exactly how you want to.
4. Life Insurance Can Be Used As A Retirement Fund
One of the best things about cash value life insurance is its potential to fund your retirement plans. With universal life insurance, you can pay extra premiums in the early years of your policy, then claim the cash value of those premiums when you reach a certain point. Depending on your insurer and their policies, you may also have the option to receive your cash value as an annuity, supplementing your pension/retirement income.
5. You Can Get Tax Benefits For Estate Tax
According to a recent report by Forbes, the federal estate tax exemption limit is at $11.58 million. If your estate exceeds this, your legal heirs must pay income tax. But with a whole life insurance policy (or most insurance policies for that matter), the death benefit is usually tax-free. By investing some of your inheritable funds into a life insurance policy, you can give your heirs certain tax advantages. Plus, they can use the death benefit to pay off any estate tax that they may still owe.
3 Reasons Why Life Insurance May Not Be The Best Investment
Even though there are many reasons life insurance can make for a practical investment, that’s not always the case. In some instances, life insurance just isn't the right choice. Here are three reasons why life insurance might not be the best option for you:
1. Term Life Insurance Provides No Investment Option
A term policy is relatively straightforward – you get coverage for a certain number of years, and if you die within that insurance term, your beneficiaries get a death benefit. If you outlive your term, your beneficiaries don't get anything.
Since term life insurance is more affordable than whole life insurance, this is a great option for people on a budget. But since it doesn't come with a cash value component, it isn't the best choice for people who want to grow their money.
2. Whole Life Insurance Can Be Expensive To Maintain
When insurance agents talk about insurance as an investment, they often gloss over the fact that permanent life insurance (whole life insurance, universal insurance, etc.) can be expensive to maintain.
Aside from the high cost of whole life premiums – which can sometimes go up to 10 to 15 percent more than the premiums for term life insurance –, you'll have to pay for administrative fees and penalties. Here are a few fees you might have to face with a whole life insurance policy or universal life insurance policy:
Administration fees: This is the cost of maintaining the policy. This includes record keeping, processing claims, accounting, and the like.
Early surrender charge: You have to pay this if you choose to terminate your policy within the period specified by your insurer. It’s usually more than one year’s worth of premiums, but this varies depending on the insurer and type of policy.
Transaction fees: Some insurers charge fees for withdrawals, transferring funds among investment options (if you're on a variable policy), and the like.
Mortality and expense risk fees: M&E fees cover for the risk your insurer assumes to provide you with coverage.
With all of these additional fees and charges, it might not be worth it to maintain a policy. But if you’re adamant about buying permanent life insurance, there are ways to lower the cost of premiums:
Buy insurance as early as possible, since insurance gets more expensive as you get older.
Don't skip the medical exam. Insurance companies collect your medical/health information so that they can mitigate risk as much as possible. If you’re unhealthy or unwilling to provide this information, insurers may consider you high-risk and charge accordingly.
3. There Are Other Investment Options Out There
Aside from the usual mutual funds, stocks, and bonds, there are also plenty of savings accounts and retirement funds that may be far better investments than life insurance policies.
If you're looking for a decent retirement fund, you can always save your investments in a 401(k), a traditional IRA (where your investments will be tax-deferred), or a Roth IRA (where your money grows tax-free). You can also choose to invest in property, real estate, or even cryptocurrency.
So Is Life Insurance A Good Investment?
Ultimately, the answer depends on your financial situation, the type of insurance you choose (e.g. term or permanent life insurance), and the insurance company. There are both advantages and disadvantages to investing in life insurance, and you may want to consider other investment options (e.g. 401 k, stocks) with higher returns.
Still on the fence about investing in life insurance? At Wesley Insurance, LLC, we can help you choose the right policies and find the best life insurance companies in your area. Get in touch to find out more!