The Pros and Cons of investing in permanent life insurance
Life Insurance is something you might consider adding to your financial plan if you're interested in providing some security for your loved ones. The proceeds from a life insurance policy can be used to pay off last-minute expenses, pay off outstanding debts, or cover day-to-day expenses. Whether life insurance is a wise investment can depend on what you need and what you want a policy to do for you.
Types of Life Insurance
When deciding whether life insurance is a good investment, it's important to understand the types of policies you can buy. There are several variations of life insurance plans, but they generally fall into two categories: permanent and temporary.
Term life insurance is designed to cover you for a specific period of time, hence the name. For example, you can take out life insurance with a term of 20 or 30 years. These policies work similarly to other types of insurance policies you may have, such as: B. car insurance. You pay a premium each month and if something bad happens, in this case your untimely death, a benefit is paid.
Permanent Life Insurance, on the other hand, insures you for life as long as your premiums are paid. Certain types of permanent life insurance may also include an investment component that allows policyholders to build cash value. When you hear financial advisors, and more often life insurance agents, recommend life insurance as an investment, they are referring to the present value component of a permanent life insurance policy and the ways you can invest and borrow that money.
Pros and Cons of Permanent Life Insurance
There are many arguments for using permanent life insurance as an investment. However, many of these benefits are not unique to permanent life insurance. You can often get them in other ways without paying the high management fees and brokerage commissions associated with perpetual life insurance. These are some of the most recommended benefits of permanent life insurance.
Life insurance policies with an investment component allow you to enjoy tax-privileged capital growth. That means you don't pay tax on interest, dividends, or capital gains on the present value component of your life insurance policy until you withdraw the proceeds. This is similar to the tax benefits you get with certain retirement accounts, which include IRAs, 401(k) and 403 (b). If you're maximizing your contributions to these accounts year after year, it may make sense to invest in a perpetual life insurance policy for tax reasons.
Another touted benefit of permanent life insurance is that you don't lose your coverage after a set number of years. A term policy ends when you reach the end of its term, which for many policyholders is 60 years, while perpetual policies can cover you for life. If you anticipate that people will be financially dependent on you (e.g. a disabled child) beyond the duration of a typical term insurance policy, this benefit may be attractive to you.
You can borrow against cash value
If you need money to buy a house or pay for college, you can borrow against the cash value of a perpetual life insurance policy. On the other hand, if you put money into a tax-advantaged retirement plan like a 401(k) and want to take it out for a purpose other than retirement, you may have to pay penalties. Additionally, some retirement plans, like 457(b), make it difficult or even impossible to raise money for such purposes.
You may be able to receive between 25% and 100% of your permanent life insurance death benefit before you die if you develop a certain condition, such as an illness. B. heart attack, stroke, invasive cancer or end-stage renal failure. The benefit of so-called accelerated benefits is that they can help you pay your medical bills and potentially enjoy a better quality of life in the final months of your life.4
Although permanent life insurance can offer several advantages, there are some potential disadvantages to be aware of. Cost is one of the most important. You may have to pay higher premiums for permanent life insurance compared to term life insurance. If it turns out that you don't need life insurance coverage, you may be paying premiums unnecessarily.
Perpetual life insurance could also have tax implications for you if your beneficiaries decide to surrender a policy or if you die with an outstanding loan. And taking out loans or accelerated benefits could reduce the death benefit paid to your beneficiaries if you die.
Term Life Insurance Pros and Cons
term life insurance could be a good investment if you don't want to burden your loved ones with the burden of paying off debt or other expenses. These are some key benefits of buying term life insurance.
Term life insurance is usually cheaper to buy than permanent life insurance. This is because the insurance company takes less risk as you are only insured for a certain period of time. The younger and healthier you are when you buy term life insurance, the lower your premiums are likely to be.
One advantage of term life insurance is that you can choose how long you want to be insured. So if you think you only need life insurance for 10 or 20 years, you can choose a term that suits your needs. This means you are predictable about how much you will pay in rewards over the lifetime. Permanent life insurance, on the other hand, would be more of a guessing game as there is no fixed end date.
You can switch to perpetual life insurance
If you decide to extend your term life insurance indefinitely, you can switch to perpetual life insurance. This can increase your premiums, but it can be a worthwhile investment if you want lifetime coverage. The conversion could also give you an opportunity to build cash value.
When you buy term life insurance, all of your premiums go towards securing a death benefit for your beneficiaries. Term life insurance, unlike permanent life insurance, has no cash value and therefore no investment component. If you are alive at the end of the term, the policy simply expires and you and your beneficiaries see no money.
However, you can think of term life insurance as an investment because you pay relatively low premiums to be sure that your beneficiaries will receive a relatively high death benefit in the event of your death.
If you're interested in a policy with a fixed term and a built-in savings mechanism that rewards you later for your payments, a return-of-premium (TOP) life insurance policy can be an attractive option. You pay a flat rate for the life of your policy, but unlike traditional term life insurance, you get all your money back at the end of the term.
Term Life Insurance Example
A 30-year-old woman who does not smoke and is in excellent health could take out a 20-year policy with a $1 million death benefit for $480 per year. If this woman dies at age 49 after paying premiums for 19 years, her beneficiaries will receive $1 million tax-free if she only paid $9,120.
Term life insurance offers an unparalleled return on investment should your beneficiaries ever need to claim it. However, it offers a negative return on investment if you are among the most policyholders whose beneficiaries never file a claim. In this case, you've paid a relatively small price for your peace of mind, and you can celebrate the fact that you're still alive.
Example of permanent life insurance
What if the same woman had permanent life insurance as described above? For a life insurance policy from the same insurance company, you can expect to pay $9,370 per year. So how much cash value would you accrue for these additional costs?
- After five years, the guaranteed cash value of the policy is $19,880, and you have paid $46,850 in premiums.
- After 10 years, the guaranteed cash value of the policy is $65,630, and you have paid $93,700 in premiums.
- After 20 years, the guaranteed cash value of the policy is $181,630, and you have paid $187,400 in premiums.
But after 20 years, if you bought the term for $480 per year and invested the difference of $8,890, at an 8% average annual return, you would have $421,064 before taxes.
“Sure,” you say, “but long-term life insurance guarantees your returns."That's right. But even if the woman described above had put the additional $8,890 per year into a savings account paying 1% interest, after 20 years she would have $196,425, which is still more than the guaranteed cash value of the account." $181,630 permanent policy.
Is life insurance a smart investment?
Using permanent life insurance as an investment might make sense for certain high net worth individuals who want to minimize inheritance taxes. But for the average person, buying forward and investing the difference is often the best option.
Even if you're buying life insurance primarily for investment purposes, it's still important to research the best life insurance companies to ensure you're getting the best possible policy.