Category: Life Insurance Blog
The Pros and Cons of Using Life Insurance as an Investment
March 24, 2017 Richard Reich
When we consider using life insurance as an investment, there are as many people in favor of it as there are opposed. Certainly, financial gurus like Dave Ramsey and Suze Orman are against life insurance for any reason other than a death benefit, but remember, while speaking out against most life insurance products, they are at the same time, trying to sell their financial planning programs. They are part of the group who advises “buy term and invest the rest.”
The truth is every type of life insurance (and there are many) can be used as an investment in some way. What’s most important to understand, is that your needs and expectations will determine whether life insurance is the appropriate solution. There are certainly many reasons for investing, and the vehicle you select is probably the most important consideration you’ll make.
Why We Invest
In simple terms, we invest to earn passive income. Passive income is income that is derived while not doing current work. We earn while we’re sleeping, on vacation, or at work. What we do with this passive income is what makes us decide on the type of investment to consider.
- Retirement Planning
- Saving for college tuition
- Supplementing traditional income
- Additional earnings for large purchases such as a home or business
- The ability to live off investments
Different uses of passive income typically include all or some of the following:
Insurance as an Investment
As previously stated, every type of insurance product can be used as an investment, but first, we need to discuss each type of insurance and then discuss the benefits it would return.
Term Life Insurance
Term life insurance is the most affordable life insurance in the marketplace. Since term insurance does not build cash value, most people believe that it serves no purpose as an investment. Term insurance is not considered permanent insurance and therefore policyholders either let the term run to completion, convert the policy to permanent insurance or cancel it to buy permanent insurance.
A primary use for term insurance is to cover debts in the event the policyholder dies unexpectedly. It’s perfect for younger adults who are starting a family and will likely be accumulating substantial debt. Since term is so affordable, it is the least expensive way to purchase a death benefit to allow surviving loved ones to continue with their lives without fear of financial devastation that could result from losing the family’s primary income. Term can, however, be used as an investment vehicle if the applicant purchases a rider called “return of premium.”
Return of Premium Rider
The return of premium rider allows the policyholder to collect all premiums paid into the policy if the policyholder outlives the policy period (typically 20 or 30 years). The additional cost for this rider is typically somewhere between 20 and 50 percent, depending on your age and the insurance carrier you select. Here is how term insurance can be used as an investment vehicle:
John Jones is a 30-year-old male non-smoker in excellent health. John purchases a $500,000 30-year term policy and elects the return of premium rider. John’s premium for the insurance and rider is $62 per month. At the end of the policy period (30 years), John is still alive, so the insurance company sends John a check for $22,320 which represents the premiums he has paid over the term of the policy. Since John has another permanent insurance policy, and his house is paid off, John elects to invest the non-taxable $22,320 into his retirement plan as a supplement. His family would have received the $750,000 if he died, and John receives $22,320 if he lives. John is a winner!
Universal Life Insurance
Universal Life, a newer product compared to term and whole life, is considered permanent insurance that offers the lower premiums like term, but also a cash value account like whole life. With Universal Life, the policyholder receives the same benefits of term and whole life insurance, but also policy flexibility that is not available in the other products.
When Universal Life insurance is purchased, the policyholder pays a premium that covers the cost of insurance, and an additional amount that is placed in a savings account. This “savings account” earns interest on the cash account which is stated in the contract. When the insurer’s investments perform better than expected, the cash account earns additional interest based on the company’s performance, rather than the minimum rate. This additional premium that is paid by the policyholder, plus the accumulated interest is available to supplement the premiums paid in the policy’s latter years when cost of insurance increases because of the age of the policyholder, and thereby allowing the policy to be considered permanent.
Unlike traditional insurance, Universal Life is flexible regarding premium payment and face amount. Since life is not a static event, the Universal Life policyholder can change the amount of the periodic premium or change the face amount of the policy according to their needs.
Knowing that the policy will be flexible when needed, is one of the most popular reasons that consumers are attracted to this type of insurance.
Since insurance carriers typically pay a greater amount of interest toward the cash value in Universal Life than is paid toward Whole Life insurance, the insurance policy acts as much as an investment vehicle than it does a life insurance policy. The accumulation of cash in the policy can be accessed through policy loans or partial surrender without tax liability. If the policy loans are not repaid, the death benefit will be reduced accordingly. With Universal Life, the policyholder can purchase affordable life insurance and look forward to building a cash account that can be invested in the later years of the policy.
For consumers looking for a more aggressive investment, there is a Universal Life policy (Indexed Universal Life) that allows the policyholder to invest funds into an account that earns interest based on certain market indices (e.g. the S&P 500), which allows it to earn considerably more interest.
Whole Life Insurance
Whole Life, considered the bedrock of the insurance industry, is a permanent insurance product that, once issued, has a guaranteed death benefit and a guaranteed periodic premium, and cannot be canceled as long as premiums are paid. Like universal life, whole life has a cash account that is credited by the insurance company and builds cash value over time. The accumulated funds in the cash value account can be accessed through policy loans or withdrawals.
If the policy is issued by a mutual life insurance company, the policyholders, rather than shareholders, are owners of the company. As such, any dividends are paid to the policyholders and can either be taken as distributions or be added to the cash value of the policy. Additionally, with paid up additions, additional death benefit can be used to increase the death benefit. These dividends can be a great to way earn passive income to accommodate the needs of the policyholder.
Using life insurance as an investment, like any other investment strategy does have pros and cons. But the most important consideration should be based on the needs and expectations of the policyholder. For individuals who are in need of a conservative method of investing and also want to financially protect their surviving loved ones in the event of unexpected death, insurance may be the best way to accomplish their investment goals.