Forbes and other trusted sources say that life insurance is a good investment — but is it true? The blanket statement is a broad generalization that doesn’t really delve into the complexities of the different types of life insurance policies and the ROI they provide as opposed to other investments.
What Kind of Life Insurance Can Act as an Investment?
There are several life insurance categories, but the two most popular are term and whole. Term life insurance, also known as “pure” life insurance, is purchased for a certain amount of time, i.e. 10, 20, or 30 years, and is only valid for that time period. Once the term is over, your coverage ends. The main benefit of term life insurance is that it’s much more affordable than whole life insurance, and it does exactly what it’s supposed to do for the specified term.
College graduates, new parents, parents who want to put their kids through college, and people with a mortgage or business usually choose term life insurance as a way to provide financially for these things should they die unexpectedly. For example, a parent with young children who wants to ensure that he’ll have enough money to put them through college would probably buy a 20 or 25-year term policy with enough coverage to cover the cost of college. This way, even if the worst should happen to him, his children would still be able to pay for college.
When people talk about life insurance as an investment, they are NOT referring to term life insurance. As pure life insurance, it offers coverage in the event of death (with perhaps some riders) and nothing else.
Whole Life Insurance as an Investment
When people refer to the investment component of life insurance, they are usually talking about whole life insurance. Whole life insurance is a type of permanent insurance, a policy category that means the insurance lasts your entire lifetime. This is the main way it differs from term life insurance.
In addition to providing coverage, whole life insurance also has a cash value component that grows tax-deferred. This cash value is an important part of the policy because you can borrow against it to pay for a house, college, business expansion, or supplement your retirement income. You can also withdraw the funds during your lifetime, and as long as you don’t withdraw more than you put in, it’s tax-free.
Some whole life insurance policies pay dividends, which is cash that insurance companies pay out when they earn excess profits after their projected operating costs and claims have been covered. While this isn’t an investment per se, it’s another way that whole life insurance policies pay off even during the policyholder’s lifetime. Not all insurers pay dividends, so if this is important to you, make sure to look for an insurer that does. (Here is a list of the best whole life insurance companies, most of which offer policies with dividends.)
Pros and Cons of Using Whole Life Insurance as an Investment
As with most financial decisions, there are pros and cons of buying whole life insurance for its investment component.
Here are some benefits of whole life insurance as an investment:
You don’t need to pay taxes on interest, dividends, or capital gains on the cash value component of your policy.
Option to borrow against the cash value
You can borrow against the cash value of your whole life insurance policy. This particular benefit makes it preferable over a 401(k) or other retirement plans, which can penalize you for withdrawing the funds ahead of time.
Use in estate planning
The death benefit of whole life insurance is a way to pass on a tax-free inheritance. If you set up an irrevocable life insurance trust, it can protect your death benefit from estate taxes.
Some whole life insurance policies offer accelerated benefits, which allow you to get between 25% to the full amount of your whole life insurance death benefit before you die. This is an important benefit because it provides the option for financial assistance in case you have a serious health issue like a heart attack, certain cancers, stroke, and more.
Here are the cons of using whole life insurance as an investment:
Some benefits are not unique to whole life insurance
Some of the benefits of whole life insurance can be received through other investment vehicles without the need to pay high monthly premiums. For example, the tax-deferred aspect that is so wonderful can also be enjoyed with IRAs, 401(k)s, and certain other plans. It may only make sense to choose whole life insurance for the specific reason of tax-deferred growth if you’ve already maxed out your contributions to these types of accounts.
High monthly premiums
The tax-free cash value component of whole life insurance is great, but remember, it’s not free. You are paying high monthly premiums for this benefit. The question then becomes, are the high monthly premiums worth the benefits listed above? And are there other investment tools (as listed above) that can give you similar benefits without the high cost? Due to the high monthly premiums of whole life insurance, these are questions that you must answer to decide whether the investment is worthwhile.
When it comes to the question of whether whole life insurance is good for investment purposes, there is no right or wrong answer. However, there are general guidelines. Most financial advisors do not recommend using whole life insurance solely for the purpose of investment, since the fees are high and the returns are relatively low. (It can, however, be beneficial if you want life insurance that will last your entire lifetime, not for a specific term.)
People who would benefit the most from the investment aspect of whole life insurance are those who are in a high tax bracket, who have maxed out their retirement plans, who need it as an estate planning tool, are generally more risk-averse, or who want to help a family member with a disability.
Still have questions about whether whole life insurance is a good or bad investment? We’ve got answers.
Is whole life insurance a good investment for retirement?
In most cases, financial advisors do not recommend buying whole life insurance as an investment for retirement. The reason for this is that the monthly premiums are relatively high while the returns are relatively low. This, of course, is compared to other investment options, including the standard 401(k) and other retirement savings plans.
Whole life insurance is usually recommended as a retirement investment if your other retirement plans are already maxed out and you’re in a high-income tax bracket. If you are in a high tax bracket, the option to withdraw from your accumulated cash value tax-free may be worthwhile. If this describes your situation, it’s best to talk to a financial advisor.
How much can I expect to pay for a whole life insurance policy?
Every whole life insurance policy has a different cost because there are so many factors that insurers consider. These factors include:
- Height and weight
- Smoking status
- Substance abuse
- Credit and driving history
- Amount of coverage
- Type of policy
Insurance underwriters assess all of these factors and perform statistical comparisons to determine the cost of each individual’s monthly premiums.
How does the cost of whole life insurance compare to the cost of term life insurance?
Like whole life insurance, term rates are calculated by underwriters who take the same factors into account, with the added factor of term length. Whole life insurance can cost anywhere between 5 to 15 times more than term. The wide range depends on all the above factors.
Since term life insurance is more straightforward, there are many sites that offer free quotes. Whole life insurance, on the other hand, is complex in nature and it’s very hard to get an instant quote online. Most insurers require speaking with an agent just to get an initial quote. If you’d like to get an idea of how much you can expect to pay for whole life insurance, read this article that includes sample rates for both term and whole life insurance at different ages.
Are there any features of whole life insurance besides the investment component?
Since whole life insurance is not the first choice of an investment vehicle for most people, are there any other reasons to get it? Of course! Whole life insurance offers lifetime coverage, as opposed to term, which offers coverage for a specific period. This makes it a desirable commodity for people who don’t want to worry that they won’t be covered after a certain time period.
In addition to lifetime coverage, whole life insurance often allows you to customize the payment period. While you can pay once a month for the rest of your life, you also have less traditional options like paying the entire cost within a set time period or even paying it in a single payment.
Additionally, some whole life insurance policies pay dividends, the excess profits from the insurer after claims and operating costs have been covered. You can use the dividends to pay for your monthly premiums, deposit them into your cash value account, or get them as cash payouts.