Purchasing life insurance is an important personal finance decision for many. Finding the right product can provide you with the peace of mind that your family will be provided for after you are gone. Life insurance comes in many different shapes and sizes, and some products also include a “cash value” that will grow over time. So, should you use life insurance as an investment?
While everyone’s financial situation is unique, purchasing life insurance as an investment is generally not a wise choice, according to most experts. The purpose of life insurance is to ensure that your family has the means to transition to life in your absence. It is with this in mind that you should be considering life insurance products.
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How Does Life Insurance Work?
Life insurance is a financial arrangement between you and a financial institution. In exchange for premium payments during your lifetime, your beneficiaries will receive a death payment if you die while the policy is in force.
There are two main types of life insurance: term life and whole life insurance.
Term life insurance is a fairly straightforward financial product. You will pay to be protected for a particular period of time, generally ranging between 10-30 years. If you die during this timeframe, your family will receive a death benefit. If you outlive your policy, your term life insurance contract will end without any benefits being paid out.
Whole life insurance, in contrast, has multiple components. For starters, the death benefit never expires, and as long as the policy remains active, your beneficiaries will receive a payment regardless of when you die. Whole life also has a cash value, which increases over time as you make your premium payments.
Understanding the Cash Value Component
The cash value is a type of savings or investment account, growing over the years at a guaranteed interest rate. It is also known as a living benefit, meaning that as a whole life insurance policyholder, you will have the ability to access the funds in the cash value as either a loan or as a withdrawal. For most plans, however, when you die, the cash value in your whole life policy will revert back to the insurance company.
The amount you remove from the cash value will be taxed only if it includes interest you have earned after you have placed it into the account. Depending on the specifics of your plan, withdrawals and loans that are not repaid will likely reduce the death benefit that is paid out as well.
In addition, if you decide to end your insurance policy, you will receive the amount of money in the cash value that has accumulated, minus any cancellation fees that the company charges. Your beneficiaries will also no longer receive a death payment.
Should You Use the Cash Value as an Investment?
Because the money will grow over time at a guaranteed rate, it is understandable why whole life insurance might be a tempting investment. There are some reasons why this might not make the most sense, however.
(1) Low rates of return: On average, the rate of return is in the low single digits. The odds are that you can find a better rate of return by looking elsewhere, such as high-yield savings accounts or the market.
(2) Expensive policy: Whole life insurance is a complex product, and it is significantly more expensive than term life insurance.
(3) Mixed objectives: Perhaps the biggest argument against using whole life insurance as an investment is the fact that it combines multiple objectives. The stated purpose of a life insurance policy is to provide for your family after you die.
Many advisors would, therefore, counsel splitting the two objectives into separate financial vehicles. In other words, you would purchase a term life insurance policy to ensure that your family is cared for while simultaneously making targeted investments. The money you have saved by not acquiring a whole life insurance policy can then be invested in a 401(k) plan, Individual Retirement Account (IRA), or high-yield savings account.
For this reason, it is always a good idea to consult with a licensed professional before making any financial or investment decisions.
Conclusion: Building Your Future Finances
Most personal finance-related decisions revolve around balancing multiple priorities. Life insurance is no different.
Life insurance is designed to enable your family to transition to their new lives in your absence. In exchange for making payments today, you will secure a death benefit that will help your family cover future expenses after you die.
As you work on building your future finances, it is essential to understand the best pathway to achieve your long-term goals. Protecting your family and building wealth are two important goals. They do not necessarily need to be combined into the same financial product.
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