When you purchase a life insurance policy, the primary purpose is typically to cover expenses you may leave when you pass away, such as burial expenses, housing expenses, or childcare expenses.
However, there are additional types of life insurance that some policyholders purchase primarily for the investment benefits that it offers, such as living benefits that can be withdrawn from when you’re in financial need.
Knowing which type of life insurance to purchase and how it works is crucial when investing in a life insurance policy.
Which Type of Life Insurance Is Best for Investing?
When it comes to life insurance as an investment, whole life insurance is the ideal option. While a term policy will provide the death benefit needed should you pass away, it does not generally offer any return on your premium and is not a good investment option.
However, whole life insurance provides a death benefit and a return on your premium–known as cash value–that can be used as an investment tool as it appreciates over time. For this reason, whole life insurance is much better suited for investing.
Investing in Universal Life Insurance vs. Whole Life Insurance
Whole life insurance is not the only type of life insurance that you can consider when looking to invest in a life insurance policy. Another type of permanent life insurance, known as universal life insurance, may also provide a cash value making it a viable option. However, even though both types of insurance offer a cash value, that does not necessarily mean that is guaranteed.
For example, whole life insurance policies not only offer a guaranteed death benefit and set premium, but a guaranteed cash value that steadily earns interest over time. In contrast, universal life policies are more flexible in that you can adjust your death benefit and premium, and the cash value aspect may fluctuate as it is dependent upon the performance of an index, typically the S&P 500, NASDAQ 100, or Russell 2000.
If the universal life policy becomes underfunded or does not perform as well as projected, the cash value may reduce to zero. For this reason, whole life insurance is a more reliable option.
Whole Life Insurance as an Investment
When it comes to investing in life insurance, whole life insurance has many features, such as tax benefits, cash value benefits, and retirement funding, making it a good investment tool.
Potential Tax Benefits
Whole life insurance builds a cash value tax-deferred; this means that the cash value of your policy will not be taxed while it is growing. This is an important benefit to consider because not only does it mean you will not pay taxes on the cash value every year, but it also allows the cash value of the policy to grow faster because taxes are not reducing it.
Another tax benefit of whole life insurance is that the death benefit payout to the beneficiary is not taxable. If an individual has a large estate and taxes will be owed, the payout from a life insurance policy may be used to pay or offset those taxes. This will relieve the burden on your beneficiary or heirs to pay the estate taxes and ensure they receive the most value possible from your estate.
Potential Cash Benefits
Along with the tax benefits, whole life insurance also provides investment opportunities in the form of cash benefits. There are several ways these benefits are provided, such as dividends, loans, and cash value.
Dividends are a return of the premium you have paid into the life insurance policy. They are returned to the policyholder, usually on an annual basis, and can be received in several ways, including a check, applying the dividends to the premium, using the dividends to purchase additional insurance, or leaving the dividends with the company to earn additional interest.
While many life insurance companies strive to pay dividends to their policyholders, they are not guaranteed.
Life insurance companies will allow you to access a certain percentage, usually 90%, of your policy’s cash value in the form of a loan.
While the loan does not technically have to be paid back, if you pass away with an outstanding loan, that amount of the loan will be deducted from the amount the beneficiary receives. The loan value is accessible to the policyholder at any time for any reason, and the loan is not taxed at the time the policyholder receives it.
For this reason, having a whole-life policy can be beneficial if you need money for emergencies or need to tap into your investment.
When you pay your premiums on a whole life insurance policy, part of the premium is used to cover the insurance cost while the remainder goes toward the policy’s cash value; you will also gain interest on that portion tax deferred.
The cash value of your policy will be guaranteed, and it will never decrease. If you decide to cash out your policy or take a portion of the cash value, only the amount you cash out that exceeds the premiums you have paid are taxed.
For example, if you’ve paid a total of $2,000 in premiums over the lifetime of a policy, and when you cash it out, you receive $2,500 back in cash value, only the excess $500 is taxable.
Using Life Insurance as Part of Your Retirement Strategy
As a whole life policy’s cash value builds and dividends, if paid, are applied, you may see the policy cash value grow and wonder what to do with your investment.
One option is to use it towards your retirement income. For example, if you started a whole life policy at a young age, by retirement age, the cash value may be sustainable. Once you know that you no longer need the payout for your beneficiaries, you may be able to terminate the policy and cash it out, using the cash value as supplemental retirement income. This is often referred to as a “cash out surrender,” or surrendering your life insurance policy.
Drawbacks of Whole Life Insurance as an Investment
Although there are many benefits to using whole life insurance as an investment tool, there are some drawbacks.
The cash value of the policy is not immediate and may take years to accumulate. Also, during the first years of a policy, typically 10-to-15 years, the company may impose a surrender charge, which is a fee deducted by the life insurance company from the cash value if you cancel or terminate the policy early.
Another concern may be the stability of the company issuing the policy. If that company becomes insolvent or goes out of business, you may risk losing your investment. The best way to avoid this is to purchase your policy from a company that is highly rated and has a proven record of financial strength.
Accessing Your Whole Life Insurance Policy Investment
If the time comes that you feel you need to access the cash value or dividends of your policy, there are a few steps that you will need to complete.
- Determine how much is available for you to access. This is important because you want to ensure what you are withdrawing will not negatively affect the status of the policy. You can contact your insurance provider to determine this amount.
- Determine what type of withdrawal you would like to make. Depending on the type of withdrawal you make, you may be left without life insurance. For example, if you opt to do a cash surrender on the policy — or cancel it to cash it out —, the policy will no longer be in force. However, if you withdraw the dividends, you may be able to do so without any change to your policy.
- Request a withdrawal. Depending on what type of withdrawal you are taking, you may need to fill out paperwork or provide additional information. For example, if you want to cancel your policy and cash it out, you will more than likely need to sign forms provided by the insuring company.
- Decide how you would like to receive your funds. Frequently, the insurance company will offer several methods for you to receive your funds, including a check via mail or electronic transfer to your bank.
- Check on the tax implications of the withdrawal. Although a whole life policy does offer many tax advantages, there are some situations where you may owe taxes on the amount you are withdrawing. Always ask the life insurance provider to be clear on the tax implications of the withdrawal.
When Is Whole Life Insurance a Good Investment Plan?
Whole life insurance policies may provide many benefits and be a good investment plan overall. However, this type of plan may not be good for everyone.
When looking at whether to invest in a whole life policy, you will want to look at several factors such as your age, health, when you will need to access the funds, and what type of return you are looking for on your investment.
For example, if you are young and healthy, you may want to consider a whole life policy as an investment because your premiums will be lower, and you have more time to allow the policy’s cash value to build. However, if your health is poor, your insurance cost may be too high to consider whole life as an investment plan. If you are older or closer to retirement age, investing in a whole life policy may not be a good plan because it may only show low to moderate returns when you are ready to withdraw or cash surrender it, which is to close the policy early and cash it out.
Alternative Ways to Invest
Investing in a whole life insurance policy is only one way to invest your money. There are several other options, such as a 401(K), an IRA, or stocks and bonds.
Enrolling in an Employer 401(K)
An employer 401(K) is a retirement plan offered to employees that allows you to contribute a portion, usually a percentage, of your wages per pay to the retirement plan. Often, the employer will match the employees’ contributions up to a certain amount, which also contributes to the plan.
The amount you contribute is not taxed. However, when you withdraw the funds, they are taxed. Another drawback to a 401(k) plan is that it is invested in stocks. So, if the stock market declines, you may see your 401(k) value decline as well.
Open an IRA
Opening an IRA, or an individual retirement account, is another investment option. IRAs may be offered through your employer as an optional retirement plan in addition to the 401(k), but you own them.
You may also start an IRA through a private company such as a life insurance or investment company. There are several different types of IRAs, such as a Traditional or Roth, but they all work by you contributing funds into a retirement account that then gains interest. Depending on the type of IRA you select, the tax benefits may differ.
For example, a Traditional IRA is funded with pretax dollars and grows tax-deferred, so you pay taxes only when the funds are withdrawn. However, a Roth IRA is funded with after-tax dollars, so you have already paid taxes on these funds, and qualified withdrawals are not taxed.
Stock and Bond Investment
Another popular investment tool is stocks and bonds. Although you can invest in stocks and bonds separately, they are often paired together and offered as an investment tool through a brokerage or financial company.
With stocks, you purchase a share of a company; the better that company performs, the more the stock will be worth, boosting your return on your investment. However, if that stock drops, you may see a decrease in your investment.
With bonds, you are providing a company or entity, such as a bank or government, a set amount of money they will then pay back to you with a guaranteed interest rate. For example, if you purchase a two-year government bond with a three percent interest, at the end of the two years, you are guaranteed to get your initial investment back plus the three percent. While bonds are risk-free, they often do not provide the high returns you may see with stocks.