If you want to provide some protection for your loved ones, you should consider adding life insurance to your financial strategy. The proceeds of a life insurance policy might be used to cover last costs, pay off debts, or cover day-to-day expenses. The value of life insurance depends on what you need and want a policy to accomplish for you.
- Whether or not life insurance is a wise investment for you is determined by your personal resources as well as the length of time you will want coverage.
- If you wish to be insured for a certain amount of time, term life insurance makes sense, while permanent life insurance covers you for the rest of your life.
- Permanent life insurance’s investment part increases tax-free. You may also borrow against the cash worth tax-free to purchase a property or pay for your children’s education expenses.
- Alternatively, with term life insurance, all of your payments are put toward the death benefit for your beneficiaries, with no cash value and, therefore, no investment component; this means small premiums in exchange for a large death benefit.
Types of Life Insurance
When considering if life insurance is a wise investment, it’s important to understand the many kinds of plans available. There are various types of life insurance policies, but they are commonly divided into two types: permanent and term.
Term life insurance is intended to insure you for a certain period of time, thus the name. For example, you may get a 20-year or 30-year term life insurance coverage. These plans work similarly to other kinds of insurance policies you may have, such as vehicle insurance; you pay a monthly payment, and if anything unfortunate happens—in this example, your premature death—a reward is given out.
Permanent life insurance, on the other hand, insures you for the rest of your life as long as you pay your payments. Certain forms of permanent life insurance may also include an investing component, allowing policyholders to build up monetary value. When financial counselors and, more often than not, life insurance agents advocate for life insurance as an investment, they are talking to the cash-value component of permanent life insurance and the many ways you may invest and borrow this money.
Premiums for term life insurance are often less costly than premiums for permanent life insurance.
Pros and Cons of Permanent Life Insurance
There are several reasons in favor of investing in permanent life insurance. Many of these advantages, however, are not exclusive to permanent life insurance. You may often get them in various ways without incurring the hefty administration costs and agency charges associated with permanent life insurance. Here are some of the most often cited advantages of permanent life insurance.
Permanent life insurance plans with an investing component enable you to develop your money tax-free. This means you don’t have to pay taxes on any interest, dividends, or capital gains earned on the cash-value component of your life insurance policy until the profits are withdrawn. This is comparable to the tax advantages provided by some retirement accounts, such as IRAs, 401(k)s, and 403(b)s. If you’re maxing out your contributions to these accounts year after year, it may make sense to invest in permanent life insurance for tax reasons.
Another marketed advantage of perpetual life insurance is that you do not lose coverage after a certain number of years. A term insurance expires when the term expires, which for many policyholders is in their 60s, but permanent coverage may protect you for life. This benefit may be appealing if you foresee people being financially reliant on you beyond the period of a standard term insurance (for example, a handicapped kid).
You can borrow against the cash value
You may borrow against the cash value of a permanent life insurance policy if you need money to purchase a house or pay for education. In contrast, if you put money in a tax-advantaged retirement plan, such as a 401(k), and then withdraw it for a reason other than retirement, you may be subject to penalties. Furthermore, several retirement plans, such as the 457(b), make it difficult, if not impossible, to withdraw funds for such reasons.
If you have a heart attack, stroke, aggressive cancer, or end-stage renal failure, you may be eligible to collect anywhere from 25% to 100% of your permanent life insurance policy’s death benefit before you die. The advantage of expedited benefits is that you may utilize them to pay medical expenditures and potentially have a better quality of life in your last months.
Accelerated benefits are not limited to permanent life insurance; certain term plans also provide them.
While permanent life insurance has various advantages, there are some drawbacks to consider. One of the most essential considerations is cost. Permanent life insurance plans may have greater premiums than term life insurance policies. If it turns out that you don’t need life insurance, you may be paying premiums that aren’t necessary.
Permanent life insurance may also have tax ramifications for you and your heirs if you elect to surrender a policy or die with an outstanding debt. Taking out loans or accelerating benefits may also lower the death benefit awarded to your beneficiaries when you die.
Pros and Cons of Term Life Insurance
If you don’t want to burden your loved ones with debt or other expenditures, term life insurance might be a wise investment. Here are some of the most significant advantages of acquiring a term life insurance policy.
Term life insurance is often less costly to obtain than permanent life insurance. Because you’re only protected for a limited time, the insurance provider accepts less risk. When purchasing a term life insurance policy, the younger and healthier you are, the cheaper your rates are likely to be.
One benefit of term life insurance is that you may choose the length of coverage. So, if you anticipate you’ll only need life insurance for 10 or 20 years, you may choose a term that fits your requirements. That means you can estimate how much you’ll spend in premiums over the course of the term. A perpetual life insurance policy, on the other hand, would be more of a guessing game since there is no set expiration date.
You can convert to permanent insurance
If you wish to change your term life policy to permanent life insurance coverage, you may do it forever. This may raise your rates, but it may be a reasonable investment if you desire life insurance. Converting may also provide you with the possibility to amass monetary worth.
When you get a term insurance, all of your premiums are used to provide a death benefit for your beneficiaries. Term life insurance, as opposed to permanent life insurance, has no cash value and hence no investment component. If you are still alive at the end of the term, the insurance simply expires, and you and your beneficiaries get no money.
However, you may think of term life insurance as an investment in the sense that you are paying relatively low premiums in return for the peace of mind that your heirs would get a reasonably significant death benefit in the case of your death.
If you want a policy with a built-in savings mechanism that compensates you for your payments later on, a return of premium (ROP) life insurance policy may be an appealing alternative. You’ll pay a set rate for the lifetime of your policy, but unlike standard term life insurance, you’ll receive your money back at the end.
Term Life Insurance Example
A nonsmoking 30-year-old lady in good health may be able to purchase a 20-year term insurance with a $1 million death benefit for $480 per year. If this lady dies at the age of 49 after paying premiums for 19 years, her descendants would get $1 million tax-free, despite the fact that she only paid $9,120.
If your beneficiaries ever need to utilize it, term life insurance delivers an unrivaled return on investment. However, if you are among the majority of policyholders whose beneficiaries never submit a claim, it gives a negative return on investment. In such scenario, you’ll have paid a modest price for peace of mind, and you may rejoice in the fact that you’re still alive.
Permanent Life Insurance Example
What if the same lady mentioned above had instead purchased perpetual life insurance? She may expect to spend $9,370 per year for a full life insurance policy from the same insurance firm. So, how much money would she save for that additional expense?
- After five years, the policy’s guaranteed cash value is $19,880, and she will have paid $46,850 in premiums.
- After 10 years, the policy’s guaranteed cash value is $65,630, and she will have paid $93,700 in premiums.
- After 20 years, the policy’s guaranteed cash value is $181,630, and she will have paid $187,400 in premiums.
However, if she had purchased term for $480 a year and invested the $8,890 difference at an annual return of 8%, she would have $421,064 before taxes.
“”Yes,” you answer, “but the permanent life insurance policy ensures its recovery.” In the market, I’m not promised an 8% return.” That is correct. Even if the lady mentioned above had saved the additional $8,890 each year in a savings account earning 1% interest, she would have $196,425 after 20 years, which is still more than the guaranteed cash value of the permanent insurance, which is $181,630.
Is Life Insurance a Smart Investment?
For some high-net-worth people trying to reduce estate taxes, investing in perpetual life insurance may make sense. However, for most people, purchasing term and investing the difference is typically the preferable choice.
Even if you’re buying life insurance to invest in, it’s still crucial to investigate the top life insurance companies to ensure you’re obtaining the finest coverage available.
Investopedia does not provide tax, investment, or financial advice. The material is offered without regard for any individual investor’s investing goals, risk tolerance, or financial circumstances, and may not be appropriate for all investors. Investing entails risk, including the possibility of losing money. Investors should consult with a financial advisor to develop an appropriate retirement savings, tax, and investment plan.
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