A well-rounded investment portfolio is something many people strive for but don’t know how to achieve in the best way financially for their situation. An investment tool that some consumers tend to forget is life insurance.
You know that life insurance will benefit your loved ones should you pass away unexpectedly, allowing them not to be burdened by funeral costs and your debts. However, looking at life insurance as an investment to help boost your financial investments can be a wise option.
Life Insurance for Protection vs. Life Insurance for Investing
A life insurance policy is purchased so that your beneficiaries don’t have to be burdened with the financial impact of your death.
Using life insurance as an investment is very different, though not mutually exclusive. Permanent life insurance can be an investment tool you add to your financial portfolio that will provide cash value, dividends, and cash-out options depending on the type of policy.
Which Type of Life Insurance Is Best for Investing?
There are 2 types of life insurance options, but only one may be a good option for investing.
A temporary option, a term life insurance policy provides a death benefit to your beneficiary but only for a specified period. Term life is not a good investment because you will pay the premium for the length of the policy, and once it expires or lapses, that money is now gone, with no benefit to you.
If you can afford a permanent life insurance option like whole or universal, it is an investment tool that will help build your financial portfolio using the growth and tax benefits. Whole life insurance will provide a benefit for the rest of your life and builds cash value. Universal life earns interest which can be used to pay premiums, and the face amount is adjustable.
Permanent Life Insurance as an Investment
Even though in many cases you will buy life insurance for its death benefit, there are some benefits to using it as an investment. With possible tax and cash value benefits, permanent life insurance can provide an additional source of investment income when appropriately used. The income generated from a permanent life insurance policy is tax-free and grows so long as premiums are paid on time.
Potential Tax Benefits
While risk management is the main reason people purchase life insurance, you should be aware of some tax benefits for both estate and retirement planning and the cash benefits.
High-net-worth individuals could benefit from permanent life insurance. If heirs have to pay an estate tax on assets when the insured passes, a permanent life insurance policy could help offset some of those costs. Since the death benefit is tax-free if paid to a beneficiary, it would not be subject to an estate tax like other assets. If the estate contains primarily fixed or long-term assets, such as real estate, heirs may also benefit from a permanent life insurance policy since the death benefit can cover the estate tax for these items.
While only purchasing permanent life insurance for your retirement investment is not recommended, using it as an extra tool can be helpful. When high-income earners have maxed out their other retirement accounts, they might want additional tax-deferred savings vehicles.
A cash value policy may make sense if you need life insurance and can afford the high premiums while accumulating cash value.
Potential Cash Benefits
The premium includes insurance coverage, the company’s overhead, and payments toward the policy’s cash value. That cash value portion grows tax-free and is guaranteed to grow as long as you pay the premiums.
- Dividends – Though not guaranteed, many insurance companies pay annual dividends to all policyholders who invest in permanent life insurance. You can take this dividend as cash and spend as you wish or put it back into your policy as a premium payment to grow it even more.
- Loans – You can borrow money from your life insurance policy, where the company will borrow against your death benefit to understand that you will pay it back with interest. The death benefit will be used as collateral against the loan, so if it is not paid back and you pass away, the death benefit will be reduced by the loan amount.
- Withdraw – Once your policy’s cash value reaches a certain amount, after a few years, you can withdraw the cash, and as long as it is not more than what you have paid, there will be no taxes. However, keep in mind that your death benefit is reduced, and if it is more than what you paid, it will be taxed as income.
Using Life Insurance as Part of Your Retirement Strategy
Being retired should be stress-free, and so should your investments, especially if the economy is struggling. Permanent life insurance can be an added investment option that will not be significantly affected by the economy.
Having a permanent life insurance option will help you prevent the need to sell some bonds or stocks when the market is in flux, and instead use the cash value of your policy until the economy rebounds.
Also, you can use the cash for whatever you choose, so it could help you be more aggressive with your other investments if the market is good, providing you with retirement income down the road. Even better, using the cash will not put you into a higher tax bracket since it should be tax-free as long as you only take out what you paid in or less.
Your retirement investment plan should be a long-term solution. The risk and reward of long-term investing go hand-in-hand. Since the cash value of a permanent life insurance policy is stable, it can help you take on more investment risk in your overall plan without being riskier with retirement investments.
Risks of Permanent Life Insurance as an Investment
As with any financial tool, there are some risks to using permanent life insurance as an investment.
- It is a commitment – While your permanent life insurance policy is active, you are responsible for paying the premiums. Until the cash value starts to accrue, there will often be fees if you need to borrow early. Purchasing life insurance young and waiting could be one of the best investment strategies to avoid paying unnecessary fees and taxes.
- Fees and expenses – If you have an outstanding loan when you pass away or you decide to surrender the policy, there will be fees associated with your policy that you didn’t plan on. Additionally, fees charged by the insurance company are not guaranteed and can change at any time. If you have passed away, your beneficiary is the one to deal with these consequences.
- Insolvent insurer – It doesn’t happen constantly, but it is possible that the insurance company you purchase your permanent life insurance policy from will become insolvent. If this happens, your state’s guaranty association will step in and provide the benefit, but be aware that each state has a limit on how much they will pay.
Your death benefit, cash value, and interest can all be lost if the guaranty association is capped or runs out of funds. The reduction or loss can be pretty frustrating since you have already paid premiums and done your part, but something is better than nothing. You can also apply to the insurance company’s estate if there is one, but that could take many years to see, if at all.
Is Life Insurance a Good Investment Plan?
Each consumer needs to pay attention to the complicated topic of life insurance. This could be a simple exercise in risk reduction by the family breadwinner, but there are sophisticated investment options to choose from as well.
You can get a better return on investment (ROI) for your money with college savings, retirement accounts, and any other investment or brokerage accounts. You can consider life insurance as an investment to your whole financial portfolio if you have maximized your other investment options.
Because seniors have fewer financial obligations than those who are younger and healthier, life insurance may not be the best investment option for them. It is essential to consider the whole financial picture and use insurance as a supplement and not the only investment vehicle used.
Investing in life insurance may be beneficial in some cases. Still, cash value policies have limited investment options and relatively low rates of return, so be sure to look at all of your options.
Long-term, buying term life insurance at a lower cost and investing in dedicated investment products – such as mutual funds, 401(k)s, or IRAs – is likely to produce better returns than investing the cash value of a permanent life policy. It should not be ignored as something to help round out your portfolio but shouldn’t be used as the primary source of investment income when the time comes.