Life insurance is a crucial purchase in your adult life, but which kind is best for you? Do you need pure life insurance, which only offers a death benefit, or do you want life insurance with a savings component as well? Here we’ll discuss life insurance with savings: how does it work, is it worthwhile, and what options you have.
Understanding the Different Types of Life Insurance
There are two main categories of life insurance: term and permanent. The former is life insurance in its purest form — you pay a monthly premium, and in return, the insurance company commits to pay out a death benefit to your beneficiaries if you die within the specified term.
Permanent life insurance, on the other hand, is more complex. It’s a life-long policy that offers a death benefit, and it also has a savings component, often known as cash value. When people talk about the savings component of life insurance, they are only referring to permanent. Term life insurance policies do not have a savings component.
How Does the Savings Component of Permanent Life Insurance Work?
If you decide that you want life insurance and a savings plan together, you have several options. There are two main types of permanent life insurance, but each of these has its own subcategories:
Whole Life Insurance
Whole is the most popular type of permanent life insurance, because it’s usually the most straightforward. Whole life insurance offers a guaranteed death benefit, fixed premiums, and a cash value component that grows tax-deferred. Most whole life policies also have non-guaranteed cash value growth in the form of dividends. (See more about dividends below.)
Guaranteed issue is a type of whole policy that doesn’t require a medical exam or any health information at all as part of the application process. Anyone can be accepted. As such, coverage is usually limited to $25,000 and there is often a waiting period involved. Read our article about guaranteed issue.
Universal Life Insurance
Universal offers flexible premium payments and a guaranteed minimum death benefit. While universal comes with greater flexibility, its guarantees regarding the death benefit and cash value growth are not as strong as whole.
There are subcategories of universal life insurance, including indexed and variable. In these policies, the cash value account is tied to external markets, so the investment aspect is a little riskier.
The way the savings component works for any type of permanent life insurance is similar: part of your monthly premium goes toward the death benefit, a portion goes to the insurer for administration fees, and another portion goes into a cash account, which grows tax-deferred.
Benefits of Life Insurance with Savings
There are several benefits of buying a permanent life insurance policy with a savings component.
- Tax-deferred – The tax-deferred aspect of the cash value account means that you don’t need to pay taxes on your earnings, and it’s one of the more desirable aspects of this type of policy.
- Borrow against it – If you need to take out a loan, for a mortgage, car, college, or anything else, you can borrow against the cash value of your policy — and you won’t have to pay taxes on the loan as long as the policy is valid.
- Withdraw during your lifetime – Once your policy has accumulated a significant cash value, you can then withdraw portions of it to use during your time. The cash value can also be used to pay your monthly premiums.
- Dividends – Some life insurance companies offer dividends to policyholders, which means that every year you will get a certain amount of money, either from an excess of premiums you’ve paid and/or as a portion of the insurer’s profits. You have all sorts of options with dividends, which you can read about in our blog post, Whole Life Insurance Dividends.
Life Insurance vs. Savings: What’s More Worthwhile?
You may be struggling with the question of what’s more worthwhile: to put aside money in a savings account or to pay monthly premiums for a life insurance policy. The question is a good one, but it depends on what type of life insurance policy you’re considering.
Permanent Life Insurance vs. Savings
Due to the details discussed above, permanent life insurance comes with a cash value that can be used for certain things, but that money does not get passed on to your loved ones as savings. They do, however, get a death benefit.
The question of whether the high monthly premiums will be worth the death benefit — in terms of savings — is something only you can answer. But generally, for most middle-class or working-class people, the answer is usually no. In one of our previous blog posts about the average cost of life insurance, you can get an idea of how much you can expect to pay in monthly premiums for whole life insurance.
Term Life Insurance vs. Savings
Term life insurance is simple, straightforward, doesn’t accumulate a cash value, and therefore, is much more affordable. If you’re deciding between a savings account or term life insurance policy, the latter can usually provide greater financial coverage than the amount you could save. To be certain, let’s do the math.
We’ll take a typical exam: you buy a $500,000 30-year term policy when you’re 30 years old. A male 30-year old in fairly good health can expect to pay about $30/month, while a female in similar health can expect about $25 in monthly premiums. (According to the CDC, women live longer than men. For life insurance companies, this means women get lower insurance rates.)
Let’s take the higher rate of $30 a month, for the sake of this analysis. $30 times 12 months a year is $360/year. $360/year for 30 years is $10,800. As you can see, this figure doesn’t come close to the policy death benefit of $500,000. So if you’re looking to pass on savings to your loved ones, paying monthly premiums of a term life insurance policy will earn you much more than putting aside that same amount of money in a savings account.
Term life insurance offers a death benefit while permanent life insurance offers a death benefit + a savings component, also known as cash value. However, the savings aspect of a permanent policy is not the same as a traditional savings account. There are pros and cons of each, so it’s up to you to weigh the options carefully.
As with every big financial decision, it’s important to consult with an insurance and/or financial advisor so you can get the best guidance.
Still have questions? We have answers! Read on to learn more about life insurance with savings.
Which insurance covers you for life and has a savings component?
Permanent life insurance is an umbrella category that offers lifetime coverage and savings options. There are different types of permanent policies, including whole, universal, and guaranteed issue. Term life insurance is a different type of insurance than permanent. It only lasts for a specific period of time and has no savings component.
Is whole life insurance like a savings account?
The cash value component of whole life insurance can be used as a savings account. Cash value accrues in the account over time (and grows tax-deferred), both from the premiums you pay and dividends you receive. The cash can then be used for various things during your lifetime — you can borrow against it, withdraw some of it, and use it to pay your monthly premiums.
Borrowing against it makes it even better than a traditional savings account. On the other hand, different policies have their own rules about how much you can withdraw and when. Your cash value account also has different tax laws than a traditional savings account.
The question of whether life insurance counts as savings depends on your goals. People who want pure savings aren’t likely to see the benefits of a permanent policy. However, if you fit any of the below criteria, a permanent life insurance can be very beneficial, not necessarily as a savings plan, but in other ways.
- Are in a high tax bracket
- Have maxed out your retirement plan
- Need an estate planning tool
- Don’t like risky investments
- Have a family member with a disability
a permanent life insurance policy can offer benefits that other types of policies can’t.
Is whole life insurance good for retirement savings?
As mentioned above, whole life insurance can be used to save for retirement, but it’s usually only recommended if you’ve already maxed out your retirement plan. According to CNN Money, retirement plans usually have lower administrative fees and should be your first option, specifically for retirement savings.
What’s better: permanent or term life insurance?
In the world of life insurance, there’s no better or worse — there is only what’s right for YOU. Permanent life insurance has its pros and cons, as does term life insurance. The main idea behind life insurance is to provide financial protection to your loved ones in case you die.
Term life insurance accomplishes that goal at a lower cost than permanent life insurance. Permanent life insurance can accomplish that goal and offer additional benefits. For many, the higher cost of permanent life insurance is reason enough to choose term, but for those who can afford it, there are several benefits of permanent insurance, including the savings component, that can be worthwhile. As always, it’s important to consult with a financial or insurance expert before making this important decision.