Should Life Insurance Be Purchased as an Investment?
Before purchasing life insurance as an investment, a potential investor should understand a few things about the types of life insurance and how they work. Basic life insurance can be broken down into two major categories, term insurance and whole life insurance. (See also: How Healthy is Your Life Insurance Plan?)
Term insurance is insurance for which one makes annual premium payments in exchange for a death benefit. This is the least expensive type of life insurance and cannot be purchased as an investment. The death benefit is all that one receives from term life insurance, provided one passes away while the policy is active.
This type of insurance is ideal if you do not believe you will need life insurance in your later years; the older one becomes, the higher the premiums for term life insurance. The primary purpose of term life insurance is to protect those people who depend on you; as one gets older, most people accumulate retirement savings and/or their children become self sufficient, decreasing the need for term life insurance.
Whole life insurance, also known as permanent or cash value life insurance is the second type of life insurance and can be broken down into whole life, universal life, variable life, and variable universal. In general, cash value life insurance offers protection throughout one's entire life, and also includes an investment — the cash value. Only a portion of the premium payments on a cash value life insurance policy cover the actual insurance. With the other portion of the premium, the insurance company sets up an investment known as an accumulation account which is invested in interest-bearing securities.
The cash value reduces the amount at risk to the insurance company and thus, the insurance expense over time. The owner can access the money in the cash value through policy loans or other options which reduce the death benefit. Accordingly, premiums for such policies generally tend to be higher than those associated with term life insurance, at least in the earlier years.
The appeal of whole life insurance as an investment stems from the tax treatment of its accumulation account. The money in the accumulation account grows tax deferred, meaning taxes are postponed on income and capital gains. Nevertheless, there are many factors that make this type of insurance an unattractive investment option:
- There are incredibly high fees and expenses associated with buying permanent life insurance. Unless one buys a no- or low-load insurance policy, the fees and expenses erode the returns so much that it is almost impossible to compete with the returns of securities such as mutual funds. These fees and expenses are so high that they can eventually outweigh the tax deferral benefits of such policies.
- Further, the insurance companies generally provide unrealistic policy illustrations to show potential clients what their premiums and cash value will be in the future by using unreasonable interest rate forecasts. From a purely financial sense, many insurance experts suggest buying a term life insurance policy and investing the difference in premiums between the plans on your own.
- Finally, with cash value life insurance, the only benefit paid to your family upon death is the face value of the policy.
Based on this evidence, it is quite apparent that permanent or cash value life insurance is not a recommended investment. Individuals with access to other tax-deferred retirement savings opportunities, such as a 401(k) or a ROTH IRA, should be maximizing their contributions rather than investing in a cash value insurance policy.
- Life insurance, an investment? Despite what you hear, it's rarely a good choice (BNET)
- Should you use Life Insurance as an Investment? (Financial Web)
- The Truth About Life Insurance (Dave Ramsey)