Life insurance is something you may consider adding to your financial plan if you’re interested in providing a measure of security for your loved ones. Proceeds from a life insurance policy 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 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 purchase. There are several variations of life insurance plans, but they generally fall into two categories: permanent and term.
Term life insurance is designed to cover you for a set term, hence its name. For example, you may purchase a 20-year or 30-year term life policy. These policies function similarly to other types of insurance policies you may carry, like car insurance; you pay a premium each month, and if something bad happens—in this case, your early death—there’s a benefit paid out.
Permanent life insurance, on the other hand, covers you for life as long as your premiums are paid. Certain types of permanent life insurance can also have an investment component that allows policyholders to accumulate a cash value. When you hear financial advisers and, more often, life insurance agents advocating for life insurance as an investment, they are referring to the cash-value component of permanent life insurance and the ways you can invest and borrow this money.
Pros and Cons of Permanent Life Insurance
There are many arguments in favor of using permanent life insurance as an investment. However, many of these benefits aren’t unique to permanent life insurance. You can often get them in other ways without paying the high management expenses and agent commissions that come with permanent life insurance. Here are a few of the most widely advocated benefits of permanent life insurance.
Pro: Tax-deferred growth
Permanent life insurance policies that have an investment component allow you to grow wealth on a tax-deferred basis. This means you don’t pay taxes on any interest, dividends, or capital gains on the cash-value component of your life insurance policy until you withdraw the proceeds.1 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.
Pro: Lifetime coverage
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 your term, which for many policyholders is in their 60s, while permanent policies can cover you for life. If you anticipate people being financially dependent on you beyond the length of a typical term policy (for example, a disabled child), this benefit may be attractive to you.
Pro: Borrow against the cash value
If you need money to buy a home or pay for college, you can borrow against the cash value of a permanent life insurance policy. Conversely, if you put money in a tax-advantaged retirement plan like a 401(k) and want to take it out for a purpose other than retirement, you might have to pay penalties.2 Further, some retirement plans, like the 457(b), make it difficult or even impossible to take out money for such purposes.3
Pro: Accelerated benefits
You may be able to receive anywhere from 25% to 100% of your permanent life insurance policy’s death benefit before you die if you develop a specified condition such as heart attack, stroke, invasive cancer, or end-stage renal failure. The upside of accelerated benefits, as they’re called, is you can use them to pay your medical bills and possibly enjoy a better quality of life in your final months.
Cons of Permanent Life Insurance
While permanent life insurance can yield several benefits, there are some potential downsides to keep in mind. Cost is one of the most important. Compared to term life insurance policies, permanent life insurance can require you to pay higher premiums. If it turns out that you don’t need insurance coverage for life, you may be paying premiums unnecessarily.
Permanent life insurance could also have tax implications for yourself if your beneficiaries if you decide to surrender a policy or you pass away with a loan outstanding. And taking loans or accelerated benefits could reduce the death benefit that’s paid out to your beneficiaries when you pass away.
Pros and Cons of Term Life Insurance
Term life insurance could be a good investment if you don’t want to leave your loved ones with the burden of paying off debt or other expenses. Here are some of the most important benefits of purchasing a term life policy.
Pro: Lower premiums
Term life is generally less expensive to purchase compared to permanent life insurance. That’s because the insurance company assumes less risk since you’re only insured for a set time period. The younger and healthier you are when you buy a term life policy, the lower your premiums are likely to be.