Before you look to invest in life insurance, you must understand that life insurance is more about financial protection than investing. A life insurance policy’s main purpose is to provide the financial blanket your family will need if you pass away.
Earning dollars on the money you put towards your policy can be a great benefit, but none greater than leaving your family the financial stability needed to maintain their current lifestyle.
Why You Need Life Insurance
How would your family make ends meet if you were no longer around?
Life insurance is a necessity to have if you have a family and/or others, depending on your income. If you were to die unexpectedly, would they be able to make ends meet? Although it is not an enjoyable thing, this is an important question to ponder.
For a small cost, you can put your put family in a better state financially, buying them time to be able to figure out how they are going to move forward if you were to die.
Are you in debt?
Although experts recommend paying off all of your debts by age 45, for most people, this just doesn’t happen.
More Americans than ever before are retiring without their mortgage fully paid off, student loan debt is at an all-time high, and we haven’t even mentioned the car payments and other installment loans yet.
Being in debt can be a serious problem, especially when your family no longer has an income to pay the debts off. These types of financial disasters can leave your family in shambles.
If you are financially sound and do not have all of your debts paid off, you may think that you do not need life insurance, but there is still a benefit for you. Once you die, your family will want to have a funeral to mourn your death. Funerals can rack up bills of $10,000 – $20,000 quickly.
Types of Life Insurance Policies
Term life insurance policies only cover you for a specific period of your life, whether it is a 10, 15, 20, or 30-year period. Once the term period is up, the policy can be renewed annually, but in most cases, the premium is cost prohibitive. These policies are generally cheaper than their counterpart, permanent life insurance policies.
They can be converted into permanent life insurance policies before the end of the term, and policyholders can maintain the same health class that they were rated from the beginning of their term life insurance policy.
Permanent life insurance policies cover you for the entirety of your lifespan (generally to age 100 or 121, in some cases). Since the coverage is for a longer duration of time, it is more expensive.
However, some permanent life policies offer a benefit that term-life policies do not – a potential accumulation of cash value. Over the life of the policy, the premiums paid can yield a return, which is accumulated in cash value. This cash value can be borrowed against tax-free (note: the loan amount will be deducted from the death benefit if it isn’t paid back prior to death.
Term life insurance offers protection for a limited period of time; permanent life insurance offers whole-life coverage at a higher cost but offers cash value accumulation.
Either way, life insurance is an investment in your family. With permanent life insurance, you are also leveraging it as a financial investment.
Types of Permanent Life Insurance Policies
Whole Life Insurance Policy
A whole life insurance policy is the most commonly purchased permanent life insurance policy. It offers a guaranteed death benefit as well as a cash value account that slowly accumulates. Additionally, if the insurance company is a mutual life insurance company, the company can pay dividends to policyholders, which can be applied to the growth of the cash value.
The cash value builds at a fixed rate determined by the insurer. It’s designed to reach the value of the death benefit when the policy matures (usually once you turn 100).
You can take a loan out against your cash value, but if you do not pay it back, the amount will be deducted from your death benefit.
Universal Life Insurance Policy
A universal life insurance policy offers more flexibility than a whole life insurance policy. Your cash value account earns money based on market interest rates and the performance of the insurer’s investment portfolio.
Once money has accumulated in your account, you can use the policy’s cash value to pay premiums. This policy also allows you to skip payments, but you need to maintain a minimum level of premium payment over the course of the year.
This gives you options as your economic situation changes, but if you stop or reduce premiums and the cash value account gets used up, your coverage will end.
Variable Life Insurance Policy
This type of policy offers policyholders death protection as well as cash value which can be invested in mutual fund-type accounts.
A variable life insurance policy has a greater risk because of these types of investments. Your money can grow more quickly, but if your investments do poorly, your cash value account and death benefit may decrease.
Most variable life policies have a guaranteed minimum death benefit to cover you if your investments do not go as planned.
Variable Universal Life Insurance Policy
This type of life insurance policy has the benefits of both variable life and universal life insurance.
There are the investment risks of a variable life policy, where the money is invested in mutual fund-like accounts. These policies give you the ability to adjust your premiums and death benefit as a universal life insurance policy is accustomed to.
A variable universal life policy is the most complex policy you can purchase because of all the moving parts, so make sure you fully understand the policy prior to making your purchase.
Indexed Universal Life Insurance
Indexed universal life insurance provides death benefit protection and the opportunity to build money inside your policy, called cash value, based in part on the increases in stock market indexes. Even if these indexes dip, you’re still safe with a guaranteed minimum interest rate. Also, unlike variable universal life insurance, the annual gains have a ceiling, usually at around 10%.
Tax Advantages to Leveraging Life Insurance as an Investment
Tax – Deferred Growth
The cash value provided through your life insurance policy allows your money to grow tax-free. You do not have to pay taxes on any interest, dividends, or capital gains in your life insurance policy until you withdraw the proceeds.
You can withdraw funds up to the premiums you paid without paying taxes on that money. Once you start tapping into the interest or investment growth in your cash value account, taxes will be assessed on the gains
There are certain circumstances where you are allowed to borrow against your cash value account without being penalized.
However, you might be able to borrow from the cash value account (at a low-interest rate) without being taxed on the funds. Always check with your accountant before taking money out of a permanent policy to avoid an unexpected tax bill.
Some permanent life insurance companies offer accelerated benefits, which allow you to receive a portion of your policy death benefit before you die. This is only allowed under certain health circumstances when there is a prognosis of death within 12-24 months.
These funds can be used to pay off medical bills or to enjoy a better life in the few months you have left.
This is typically a benefit that is offered at no cost by the insurance companies. Please note, however, that the death benefit will be reduced by the amount that was accelerated. Also, by accepting these funds, government assistance you may be receiving can be terminated.
Life insurance companies invest the premium (minus expenses) that is provided by their policyholders. This is where life insurance companies earn their money.
Since some life insurance companies do not have shareholders (known as mutual companies), they are technically owned by their policyholders. If the insurer makes more money than is needed to run the business, they give some of it back to policy owners through dividends.
To qualify for a portion of this dividend, you must own a cash-value life insurance policy. Dividends are not guaranteed, but most top mutual life insurance companies do circulate their excess profits.
Disadvantages of Leveraging Life Insurance as an Investment
Expensive management fees and agent commissions
Not only is a permanent policy significantly more expensive than a term-life policy, there are also management fees and agent commissions attached.
These fees might make it unattractive to use this as an investment tool because you’re already paying such a high premium.
What happens to my cash value if I die?
A life insurance policy’s cash value is separate from the death benefit, so your beneficiaries would not receive the cash value if you pass away. The money in your cash value account is kept by your insurer.
The sole purpose of the cash value portion of your policy is to provide value to you even if you do not end up using the life insurance policy. You receive this cash value if you cancel the life insurance protection.
Which Type of Life Insurance Policy is Right for Me?
When it comes to term vs. permanent life insurance, the question of which is better really comes down to these main factors:
- Coverage needed
- What you can afford
For those who need quick coverage, small coverage amounts, or for those who can only afford low monthly rates, term life insurance may be best for you.
Many policies offer the option to convert term life insurance policies to universal life insurance, but the premiums of the new policy often cause sticker shock when the policyholder receives the statement.
For those who can afford higher premiums and are looking at life insurance as an investment, permanent life insurance may be best for you.
Over time, you can accumulate a large amount of cash value which can be borrowed on a tax-free basis. If you purchase a permanent life insurance policy at a young age, you can potentially accumulate massive amounts of cash value over time.
Return on Investment of Permanent Life Insurance
There’s an old saying in the insurance business that life insurance isn’t purchased – it’s sold. I believe that, with the advent of Internet shopping, that concept has changed to a degree.
On a website like LifeInsure.com, visitors can learn about life insurance at their leisure, decide what type of policy to purchase, and then compare prices and start the application process on their own. This has certainly been a paradigm shift in how life insurance is purchased (or sold).
Due to the simplicity of the product and the cost, I believe that most people are better served by term life insurance than they would be by a permanent policy (whole life, universal life in various flavors).
It requires very little selling on the part of an agent, and due to the Internet, it makes it very simple for a consumer to compare and purchase without the (sometimes unwanted) help of an agent or broker.
Permanent policies, on the other hand, are quite intricate, and there are many “moving parts” that make it difficult for the average consumer to comprehend. I believe, in these cases, a good life insurance broker/agent is needed to walk the consumer through the intricacies of the policies.
Life insurance as an investment is a concept I have been hearing a lot about lately. Unfortunately, there are quite a few marketing organizations out there that recruit and minimally train armies of inexperienced agents selling these products they, themselves, barely understand.
A few of these organizations have geared up to marketing and selling the new “hot” product in the marketplace – Indexed (or Equity Indexed) Universal life insurance policies.
I can always tell when one of my prospective clients has been approached by this new breed of “agent” because the first thing they ask me is, “If I invest in your policy, will I get 8% returns?”
Unfortunately, these products are being marketed and sold as “investments” rather than as cash-value life insurance policies that will pay a death benefit to one’s heirs and might accumulate some cash value.
As with other kinds of permanent life insurance policies, Indexed UL policies have the potential of building up a cash value that can accumulate on a tax-free basis that a policyholder can access on a tax-free basis later in life. Notice I said “potential” and not “guaranteed.”
All permanent life insurance quotes are illustrated, showing both guaranteed and non-guaranteed potential growth of the cash value. To only focus on the non-guaranteed column is a misrepresentation if the agent doesn’t stress that the growth shown in the illustration is not a prediction of future performance and that the guaranteed column might very well represent future growth.
Life insurance is designed, first and foremost, to pay out a death benefit on the death of the insured. I believe it should be approached on this basis – not on the basis of whether or not it will be a good “investment.” It is an investment – one in the future security of your family in the event of your death.
I believe there are some people who can benefit from a permanent policy, be it whole or universal life. I’m afraid, though, that most people would be better served by a term life insurance policy and traditional qualified (tax-deferred) investments.
How to Know Which Type of Life Insurance is Best for You
Life insurance can be a confusing concept for people to wrap their heads around fully. After all, you have a family to take care of, kids to get to soccer practice, a job to work and somehow need to find time to get some sleep in between.
This doesn’t leave much time for the mundane task of finding life insurance policies that best fit your situation. Don’t let your lack of knowledge about life insurance lead to purchasing the wrong type of policy. Give us a call today, and one of our experienced agents will be able to discuss all of your life insurance options with you and explain whether or not life insurance as an investment makes sense for you.
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