Is Life Insurance a Good Investment?
Life insurance coverage is often marketed as alternative forms of investment. The fact that some of the policies have an investment like characteristics makes them good investments in some scenarios.
Before getting into whether life insurance is a good investment, it is important to have a clear understanding of the two main types of life insurance coverage.
Term Life Insurance
Term Life insurance is a type of life insurance devoid of a cash value component. Instead, you pay a premium to an insurance company during the term of the policy. If you die, the insurance company will pay your beneficiaries an agreed amount.
Term life insurance has no investment component as all the premiums paid to go towards securing the death benefit. Some people envision term life as an investment as by paying a small amount of premium, a relatively large death benefit is always on offer.
The death benefit paid is free of federal income taxation.
Permanent Life Insurance
Permanent life insurance coverage, on the other hand, comes in a number of varieties such as whole life, universal life, and variable life. With all the types of permanent life insurance, you pay a much higher premium than the term life insurance. The difference is normally deposited in an investment account; thus, the cash value component.
Pitfalls of life insurance as an investment.
Permanent Life insurance is most of the time marketed for its tax-deferred growth that protects the insured from taxation of interest, dividends, or capital gains until the withdrawal is made. Unknown to most people is that you can still enjoy this benefit by investing in other retirement accounts, so it is not unique to life insurance coverage alone.
While money in permanent life insurance grows tax-free, contributions are not tax-deductible which significantly affects the benefits
4% Guaranteed Return
Most whole life insurance coverage guarantees a minimum return of about 4% a year. While it might sound like a good deal as it is more than one can get in other savings accounts, that is not always the case.
The problem is that most people never get to enjoy the 4% return. Most permanent life insurance goes as far as paying out less than 1% in guaranteed returns much lower than what other investments are paying.
A good chunk of the premiums paid in the early years of whole life insurance, go towards fees such as administrative costs. For this reason, it might take more than ten years to break even on an investment in Whole life insurance, which significantly reduces the number of investment returns that one gets to walk away within the short term,
Whole Life Insurance Is Expensive
According to CFAinsure, permanent life insurance comes with an investment aspect compared to term life insurance coverage, it tends to be expensive. For starters, the premiums are much higher than term life, in some cases ten times more expensive. The difference in premiums can be invested in high yielding financial products.
Likewise, permanent life insurance comes with many recurring fees that eat into the coverage investment component. The rule thumb of investment is to invest in products with low costs for optimized returns.
Any good investment is one that has a diversification component to ensure people are shielded from turmoil from one asset class. Permanent Life insurance, despite being an investment product, is undiversified, which means you are investing in one company in the hope that it performs. Should anything go wrong, then you stand to lose big, given the lack of diversification.
Ideal Time To Invest In Life Insurance
Life insurance is not all gloom when it comes to investments. Life insurance would make a lot of sense as an investment product when one is dealing with a special needs people who need sufficient financial resources over a given period.
Life insurance would also make a lot of sense for people with so much money that they would
like to preserve and pass down to their families. If you have maxed out all your tax-advantaged accounts, then life insurance would be ideal as savings for retirement.