If anyone has ever talked with you about life insurance being an investment, you have probably heard the saying “buy term and invest the difference”. This saying is based on the premise of buying low cost term life insurance which frees up money for investments. Permanent life insurance, life insurance that has a cash value component, is also recommended when talking about using life insurance as an investment.
Life Insurance agents and financial advisors agree that life insurance is a key component to your financial portfolio, but when talking about using life insurance as an investment vehicle, they couldn’t disagree more. We are going to talk about the pros and cons of using a life insurance policy as an investment. At the end we will give our thoughts on whether it is a good investment or not.
Advantages of using Life Insurance as an Investment
- Tax Deferred Growth on Investment: The cash value component of a permanent Life Insurance policy grows tax deferred during the life of the policy. That means no taxes on interest, capital gains, or dividends.
- Tax-Free Withdrawals/Loans- While these policies grow tax deferred, you can also withdraw and take out loans tax free as long as the policy remains in-force. You can use the money for a down payment on a new house, children’s college education, or to help supplement your retirement.
- Life Insurance Doesn’t Expire- If you pay the required premiums you will have the death protection for life. The coverage does not expire like with a term life policy.
- Provide Critical & Terminal Illness Benefits- Some insurance carriers now offer critical and terminal illness riders on there permanent life insurance policies at no extra cost. These riders allow you to access a portion of the death benefit early if you are critically ill or terminally ill. These riders can also be activated if you have to use a nursing home or home health care services.
Disadvantages of using Life Insurance as an Investment
- Surrender Charges: Most if not all insurance carrier’s permanent life insurance policies come with a surrender period on the cash value component. This can be a problem if an emergency arises and you need access to your funds, you could have to pay a penalty to access your funds. The surrender period usually last 15-20 years depending on the carrier.
- Management Fees- The cash value component on all permanent life insurance policies have management fees which can be higher than a regular investment. Also, the COI (Cost of Insurance) increases each year which could also have a negative impact on your earnings.
- Tax-Implications- Although these policies due grow tax deferred and can be withdrawn tax free, be wary, there is a hidden danger. If these policies lapse while you are withdrawing or taking out loans, then you could be on the hook for income tax if there is a gain in the policy, which if funded properly there will be a gain.
- Death Benefits Decrease- While true that you will have the coverage for as long as you pay premiums, if you are withdrawing or taking out loans, this can have a negative impact on the death benefit. The death benefit decreases each time you pull money out of the cash value. It is equivalent to what you withdraw but can accrue interest which will cause the death benefit to decrease more.
While some of the disadvantages of using life insurance as an investment are valid points, with the guidance of an experienced agent I believe Life Insurance can be used as productive investment vehicle. I would recommend using an Indexed Universal Life policy.
The key to using a life insurance policy as an investment is to treat it like an investment. If you put the bare minimum premium into an Indexed Universal Life policy, then you will get minimum return and basically all you have is a permanent life insurance policy.
It is important to fund these types of policies to the max to get the full benefits that are allowed under the insurance umbrella. Properly funded, permanent life insurance policies can be another tax-free retirement plan in your financial portfolio.
It is always recommended to team up with an experienced agent that is knowledgeable in these types of plans. If you have any comments or questions, please give us a call.