Is Life Insurance Worth It?

If you wish to offer your family a measure of security in the event of your death, you might consider adding life insurance coverage to your financial plan. Proceeds from your life insurance can be used to pay final expenses, eliminate outstanding debts, or cover day-to-day expenses. Whether life insurance is a smart investment may depend on what you need and need for the policy.

Key Takeaways

• Life and health insurance should be considered based upon your current income and coverage requirements. 
• Term life insurance may fit your needs if you are prepared to get coverage for a predetermined period of time. Permanent life insurance can provide lifelong protection.
• The investment in permanent life insurance can be withdrawn tax-free. You could also borrow against the cash value to buy property, pay for college costs for your kids, or for any other purpose of your choosing.
• With a term life insurance policy, all your payments are applied to the death benefit for your beneficiaries, without any cash value, and therefore no investment component. This means small premiums in exchange for a large death benefit.

Types of Life Insurance

You have to understand the type of life insurance policies available to purchase before choosing to invest in life insurance. There are many different varieties of life insurance coverage, but the two main categories are permanent and term.

Term life insurance protects a person for a specific time period, which explains its name. For example, you may purchase a 20-year or 30-year term life insurance. Like other forms of insurance you could carry, such as auto insurance, term life insurance generally involves monthly expenses followed by a death benefit if you go under covered.

Permanent life insurance, on the other hand, covers you during your lifetime as long as your premiums are being paid. Certain types of permanent life insurance may also have an investment fund element that allows policyholders to accumulate a cash value. When people, often finances agents, recommend permanent life insurance as an investment, they're usually referring to its cash-value component and ways that you can borrow and invest this money.

Pros and Cons of Permanent Life Insurance

There are many purposes to use permanent life insurance as an investment. However, many of these advantages aren't unique to permanent life insurance. You can get many of them yourself without paying the high management expenses and agent commissions that are part of permanent life insurance. Here are three of the major benefits of permanent life insurance.

Advantages

Tax-deferred growth

You can grow wealth on a tax-deferred basis by choosing a permanent life insurance policy that has a financial investment part. You don't pay income tax on interest, dividends, or capital gains on the capital value of your policy until you withdraw the proceeds. This is similar to the tax benefits you get with certain retirement accounts, including IRAs, 401(k)s, and 403(b)s. If you're maxing out your contributions to these accounts year after year, investing in permanent life insurance for tax reasons may make sense.

Lifetime coverage

Permanent life insurance also offers the advantage of enabling you to continue your insurance for the remainder of your life. A term policy will take effect once you reach the end of your chosen term, while a permanent policy will cover you your whole life. If the benefit you are going for allows for the financial dependency of someone beyond the length of a standard insurance policy (for instance, a child with a disability), then this may be one of the most enticing options for you.

You can borrow against the cash value

If you need to buy a house or pay for college tuition, you can borrow against the cash value of a permanent life insurance policy. Conversely, if you put funds into tax-advantaged retirement plans like a 401k and want to take it out for something other than retirement, you may have to pay penalties.

Accelerated benefits

You could receive up to $100,000 of your life insurance plan's death benefit if you develop a special condition, such as a heart attack, stroke, invasive cancer, or end-stage renal failure. Another benefit of accelerated benefits, also known as benefit stacking, is the ability to use them to pay your medical bills and obtain a better quality of life in your final months.

Disadvantages

If you're looking into permanent life insurance coverage, you should be mindful of potential downsides. Unlike term life insurance, permanent life insurance coverage may require you to pay higher premiums. If you do not want to insure your life, you may not be paying premiums for a purpose.

Permanent life insurance might also have tax implications for yourself if beneficiaries in case you surrender your policy or death occurs with a loan outstanding. Taking loans or accelerated benefits will reduce the death benefit that is settled to your beneficiaries after you pass away.

Pros and Cons of Term Life Insurance

It might be a sound investment if you aren't planning on leaving your loved ones with the burden of settling your debts or covering any other expenses. Here are some of the most important advantages associated with purchasing a term life policy.

Advantages

Lower premiums

Term life insurance policies are more economical to purchase than permanent life insurance because you are only covered for a set time period. The older and healthier you are when you purchase a term life policy, the lower your premiums will be.

Flexibility

Term life insurance may allow you to pick how long you will need coverage. So if you'd like coverage for ten years or 20 years, you can select a term that matches up with your particular needs. This gives you predictability in estimating how much you'll have to pay in premiums over the whole term. In general, a permanent policy would be more of a guessing game than a fixed policy.

You can convert to permanent insurance

If you want to extend the life of your structured protection policy, you could change it to genuine life insurance coverage. The change might affect your payment, but it may be advantageous for you in the long run if you want to have life insurance coverage. Converting the policy also gives you the opportunity to accumulate cash value.

Disadvantages

The premiums of all term life insurance policies are set to be spent on a death benefit for your beneficiaries once the term insurance policy expires. Term life insurance differs from permanent life insurance in that it doesn't come with a cash accrual capability. You'll be alive and eligible once the policy expires, which means that you won't have any credits.

However, term life insurance can be treated as a financial investment, because you are paying only limited premiums for the peace of mind you feel knowing that in the event of your death, your beneficiaries receive a significantly greater benefit.

If you are interested in a policy with a built-in savings mechanism that offers a reward for your past and future payments, a ROP (return of premium) life insurance policy may be an attractive option. You'll pay a flat rate for the duration of the coverage, but you'll receive back the whole amount at the end.

Term Life Insurance Example

A smoker in her 30's in good health will qualify for a 20-year life insurance term with a death benefit of $1 million for $480 annually. If she dies at age 49 after paying premiums for 19 years, her beneficiaries will be credited $1 million tax-free when they paid in only $9,120.

Term life insurance investors are able to anticipate a high return on investment should they ever need it, while those who are less likely to file a claim receive a negative return. Therefore, you have secured yourself for a very low cost, and you can bring comfort to the fact you are still living.

Permanent Life Insurance Example

If the exact same woman in the above scenario had purchased a thrift policy instead of a permanent life insurance policy, she may have paid approximately $9,370 per year for the exact same coverage. How much cash value would she accrue for that extra cost?

• The guaranteed cash value of the policy after 5 years is $19,880, and the total premiums at this point are $46,850. 
• After 10 years, the guaranteed cash value of the policy is $65,630, and the total premiums at this point are $93,700. 
• After 20 years, the guaranteed cash value of the policy is $181,630, and the total premiums at this point are $187,400.

But after 20 years, if she had bought the term for $480 a year and had invested the $8,890 difference, at an average return of 8 percent, she would have $421,064 before taxes.

"Sure," you say, "but the permanent life insurance policy guarantees its return. I'm not guaranteed an 8 return in the market." That's true. But even if the woman described above had put the additional $8,890 per year in a savings account with 1 interest, she would have $196,425 after 20 years, which is still more than the guaranteed cash value of $181,630 for the permanent policy.

Is Life Insurance a Smart Investment?

Permanent life insurance might be a smart move for wealthy individuals who are seeking to reduce estate taxes. However, for individuals, investing in term and spending the difference is usually the more straightforward option.

Even if you're purchasing life insurance mainly for investment reasons, it's still essential to assess various life insurance companies so you are sure to obtain the most effective coverage possible.