When people purchase life insurance policies, they pay premiums and, in exchange, when they die their beneficiaries will be provided with death benefit payouts in the form of a lump sum from the insurance company.
Life insurance is a way to help the people you love if you die, especially if they depend on you financially, whether wholly or partially. Some people also utilize life insurance as a savings tool. Life insurance might not be a good investment option for everyone, however.
Not all types of life insurance policies are the same. When someone talks about life insurance as an investment, they are typically referring to permanent life insurance, which can accumulate cash value, as opposed to term life insurance.
Life insurance generally falls into one of two categories. The first is term life insurance and the second is permanent life insurance.
Term life insurance is usually less expensive than permanent life insurance. Term policies provide only a death benefit, and it only pays if the policyholder dies while the term of the policy is still in effect. Policyholders buy it for a certain period, which is the term. This can vary and is usually anywhere from 5 to 30 years. The term has to be renewed if someone wants to continue coverage. It can also be converted to a whole life insurance policy.
Whole life insurance – also called permanent insurance – provides coverage for the duration of the policyholderās life. Along with paying a death benefit, it also has a cash value accumulation that builds during the policy. It usually takes an estimated 12 to 15 years for that cash value to be substantial, and some people use whole life insurance as part of their overall estate plan and investment strategy.
With a whole life insurance policy, the premiums are going to be much higher but there is an investment component as there will be savings in the policy growing at an interest rate. Furthermore, if the insured person cancels, they will be refunded part of the insurance premiums theyāve paid.
There are also other features, known as riders, that can be attached to a life insurance policy. These can include things like a disability income rider, which provides supplemental income if the policyholder becomes totally disabled. There is also a childrenās term rider so that you can add term life insurance coverage on all of your children. Riders are a way to customize life insurance to your specific needs or the needs of your family.
For most people, the primary benefit of purchasing a policy from a life insurance company is the protection it provides to their family. Some of the cheapest term life insurance policies may only require a premium payment of around $10 a month, and your loved ones receive thousands of dollars in the event of your death. Most people would consider that a good return on investment, at least from the perspective of the family you would leave behind.
If you are the primary earner in your family, or even if you are an equal earner to your spouse or partner, a payout from a life insurance policy can significantly help your family if you die.
A case can also be made for the benefits of whole life insurance in terms of being an investment or retirement plan. As was touched on, it can be a way to accumulate cash value. The cash value is based on the return on investment, and a portion of that can be withdrawn during the life of the policy. It can also be borrowed during the life of the policy.
There tends to be a peace of mind element that comes with the purchase of a life insurance policy as well, and that can be invaluable. If you have saved relatively little money and you worry about your spouse or children in the event of your death, a life insurance policy can take away some of that worry.
There are some specific benefits of a whole life insurance policy as opposed to a term life policy. First, if you purchase a whole life policy as an investment, you get growth thatās tax-deferred. Youāre not paying taxes on the interest or dividends earned on your life insurance until you make a withdrawal. This can be achieved with other investment accounts as well, however, such as an IRA.
With a permanent policy, you donāt lose your coverage after a period of time like you would if you buy term insurance, and with these policies, you can also borrow against the cash value to do something like paying for childrenās education or investing in real estate.
Someone who might consider a cash value life insurance policy as part of their estate planning would tend to be a very wealthy person. Sometimes the very wealthy will use this as a way to set up a life insurance policy that would go into effect when the other spouse dies. This would then provide a way to pay the taxes on the portion of their estate thatās not highly liquid.
Purchasing a life insurance policy is going to require you to pay a monthly premium. You personally are not going to ever realize the benefits of that policy in your lifetime. If you didnāt have a family you were concerned about providing for you if you died, there would be no reason to purchase a life insurance policy.
Also, the best life insurance policies can be pretty expensive. For example, whole life insurance or universal life insurance with all of the bells and whistles can be pretty costly.
If youāre considering a life insurance policy as an investment vehicle, you might want to really think about the long-term rate of return that you could achieve. First, there is no investment potential with a term life policy. However, there is with a whole life policy, but would you be better off investing your money somewhere with a higher return, such as the stock market? You could still provide for your family by investing your money elsewhere if you created a trust or named them beneficiaries of your account and you wouldn’t have to pay life insurance premiums.
The following are some examples of when you might not need a life insurance policy:
If you are very wealthy, a whole life insurance policy can be part of an estate plan. If you arenāt very wealthy but you have young children or a spouse who depends on your income, a term life insurance policy may be a good option.
You can then replace your income if you die, at least for a period of time. This is important when children or a spouse arenāt able to provide for themselves or if they would be greatly impacted by the loss of income your death would create.
Consider these factors as youāre deciding whether or not whole or term life insurance could be right for you:
A permanent life insurance policy can be a good investment and savings tool for certain peopleāin particular, high-net-worth individuals. It can be especially useful as a way to help minimize owed estate taxes in the event of someoneās death. Because term life has no cash value, itās not necessarily considered an investment, but a young family or someone with a spouse who depends on their income may find itās wise to purchase life insurance for peace of mind and protection for their family.
Life insurance has its benefits, but itās not a cure-all that eliminates the need for any other long-term or retirement planning.
If you are considering purchasing any life insurance policy, itās important to talk to multiple providers. Get different quotes, see what insurance options are available with specific policies, and learn more about how much it will cost you each month versus the potential benefits you or your family could derive from the policy.