Is life insurance an investment?
Life insurance as a form of protection
It’s important to understand that, first and foremost, life insurance is a form of protection from financial risk.
When you buy car insurance, it’s to help protect yourself from the financial risk of an automobile accident or theft. When you buy health insurance, it’s to help protect yourself from the financial risk of serious medical expenses. Similarly, when you buy life insurance, it’s to help protect the people you care about from some—or all—of the financial losses that might affect them if you died.
Typically, such losses could include the cost of your burial as well as your unpaid debts such as credit card bills, medical bills or a mortgage you leave behind. A life insurance policy may also help cover the expenses of raising a family or caring for a disabled family member if loved ones lose your income.
If you don’t have dependents, some financial advisors may recommend you purchase only basic life insurance to cover your burial and unpaid debts.
If you have small children and lots of expenses, you may want to consider term life insurance. Term life typically lasts for a period of your life and then expires. For example, you might purchase a term life plan that lasts for 20 years, long enough for you to raise your children into adulthood, since that’s the period you expect to have the biggest financial obligations. Term life insurance tends to be less expensive because it isn’t meant to cover you throughout a long lifetime.
The catch is, term life insurance may increase in cost over time. There are some term polices you may be able to extend, renew or convert into whole life. However, if you do not exercise one of those options, and your term expires, you no longer have life insurance, and you cannot get any of your premiums back. So, term life can help you protect your loved ones financially, but it is not an investment.
Life insurance as a form of investment
An investment is a way to grow your money.
When people invest in stocks, it is because they hope to get more money from selling the stocks than it cost to buy them. When people invest in real estate, it is because they hope to sell a property for more money than they paid for it. The main purpose of permanent whole and universal life insurance policies is to provide coverage that continues no matter how long a person lives. However, one added advantage over term life insurance is that those policies sometimes offer what’s known as “cash value.”
With some policies, some of the money you pay for premiums earns interest, which creates a fund you may be able to use while you’re still alive. That’s the cash value.
The portion of your premiums that is invested by the insurance company is likely to grow slowly over time. Once your cash value is big enough, you can often borrow money tax-free against it to pay for a child’s college education, real estate or other things you need—although keep in mind you will pay interest on that loan, and that any unpaid balance on the loan that remains when you pass away will be deducted from the death benefit your loved ones receive.
Once the cash value of a permanent policy is large enough, you may also be able to trade the entire policy in for something called an annuity. The premiums you paid into your whole life policy would be moved into an account that would give you monthly payments for as long as you live, or until the money runs out. Here again, there’s a catch. If you exchange your policy for an annuity, it might not pay a death benefit—the reason you got life insurance in the first place. Also, the the funds might not be “liquid,” meaning you might only have access to the set monthly payment, and won’t be able borrow from or withdraw the full cash value.
Finally, in some cases, and if absolutely necessary, you may be able to sell your permanent life insurance policy, or surrender it back to the company for its cash value. However, that means you will lose the insurance coverage it provides. And remember: It’s unlikely that the cash value it has built will be as great as the amount of money the policy is set to pay out when you pass away.
In some ways, permanent life insurance looks like an investment. However, it isn’t a traditional investment like stocks or real estate. The money it might make for you can be a great addition to your other investments (like savings, 401(k)s, etc.), but it isn’t a substitute for them. If you want to get a financial return from your life insurance premiums, it’s a good idea to ask an insurance agent to explain how their plan works so you know what to expect.