Life Insurance as an Investment Vehicle | FinanceHQ (2024)

Life Insurance as an Investment Vehicle | FinanceHQ (1)Are you considering life insurance as a potential investment? This guide explores the benefits and drawbacks, providing valuable insights for those seeking to use life insurance as an investment vehicle.

Life insurance is commonly considered a means to provide financial security for loved ones after we pass away. However, a life insurance policy can also be used as a financial tool to help build wealth.By taking advantage of the cash value component in a permanent life insurance policy, you can expand your investment options. In this article, we’ll explore how to use life insurance as an investment, whether it be to secure a loan or supplement your retirement savings.

What is cash value in a life insurance policy?

A cash value life insurance policy accumulates a reserve that can be used outside of the policy’s death benefit. Cash value is a savings component only available with permanent life insurance policies that provides coverage for the entire lifetime of the insured, as long as premiums are paid. The premium payments you make are split between the policy’s death benefit, insurance company operating costs, and your policy’s cash value.

As you pay premiums, your policy's cash value grows. Plus, the cash value earns interest. This accrued cash value works as an investment vehicle that you can either borrow against or use as a cash reserve.

Despite your monthly payments, you may not have access to the cash value of your policy for a few years, depending on the terms of your policy. Another key factor to consider is that the cash value of your life insurance policy is only accessible during your lifetime. When you pass away, your beneficiaries only receive the death benefit of your policy. Any remaining cash value will go back to the insurance company. That's why it's crucial to understand the difference between term vs. whole life insurance.

A term life insurance policy differs from permanent insurance. With term life, your policy spans a certain number of years. At the end of the term, your coverage ends unless you renew the policy. Permanent life insurance coverage remains in effect until your death, unless you fall behind on your premiums.

While term life premiums are much lower than what you’ll pay for permanent insurance, these policies do not have a cash value. As a result, you likely won’t use term life insurance as an investment vehicle.

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Pros and cons of cash value life insurance

If cash is king, then you might be inclined to consider the benefits of cash value life insurance:

Here are a few of the drawbacks:

  • Cost. Cash value life insurance is more expensive than term life insurance policies that cover a specific period of time.

  • Lower returns. Although the investment component of cash value life insurance policies can offer higher returns than a savings account, they often have lower returns than other options like stock market investments.

  • Benefit adjustment. Any unpaid loans and interest or withdrawals you make can reduce the death benefits paid to beneficiaries.

  • Fees and charges. Cash value life insurance policies often come with fees and charges, such as surrender charges if you cancel the policy early or fees for borrowing against the cash value.

Types of permanent life insurance

There are two primary types of cash value life insurance policies:

  • Whole life insurance

  • Universal life insurance

While both permanent life insurance policies have a built-in cash value, each has its own features, as noted below.

Whole Life Insurance

Universal Life Insurance

Premiums

Premium payments do not change as long as the policy remains in effect. Regardless of your age, you’ll pay the same monthly premium throughout the policy.

You can increase or reduce your premiums when you need to. While this can help out during times of financial difficulty, you may pay higher premiums to keep your policy in place.

Cash Value

The cash value of your policy grows at a guaranteed rate. You have some comfort in knowing the cash value will be worth at least a predetermined amount if you need to access the funds.

While the cash value grows at a guaranteed rate, the premium flexibility can change the projected cash value of your policy. There may be less certainty in how much the cash value is worth.

Tax Deferral

Cash account growth is tax-deferred.

Cash account growth is tax-deferred.

Benefits

There is a guaranteed death benefit. However, any unpaid loans upon the policyholder’s death are subtracted from the guaranteed death benefit.

Some universal life insurance policies let you change the amount of the death benefit.

Cost

Since the returns and death benefits are guaranteed, whole life policies cost more than universal life insurance policies.

Since you can lower your monthly premiums and death benefit, universal life insurance policies cost less than whole life policies.

Whole life vs. universal life: which is better?

Making the choice between whole life and universal life depends on your financial situation and goals.

You customize whole life insurance to fit your financial situation when you first take out the policy. Once the policy is set, you don’t have to worry about rising premiums or decreasing benefits. Like a universal life policy, the cash value of your plan grows tax deferred. Plus, you may also receive dividends on your whole life policy. You can leave these dividend payments in your policy to increase your cash value, withdraw them in cash, or use them to pay premiums.

Universal life insurance offers flexibility throughout the policy period. So, if you’re concerned that you don’t have enough cash to make your payments, you can lower your monthly premiums so you don’t risk losing your coverage. You can also change the value of the death benefit if needed.

Compared with whole life coverage, universal life coverage is less expensive, and you have the ability to lower your premiums or benefit. However, the growth of your cash value and death benefits are not guaranteed in a universal life plan as they are with whole life insurance.

How does cash value work?

Before taking out a cash value life insurance policy, you should compare the coverage against your financial situation and goals. Once you’ve tailored the policy to fit your needs, you need to make monthly premium payments to keep the policy in effect. If you miss a payment, you could lose your policy.

How cash value grows

Every monthly payment made is distributed across three buckets:

  • The death benefit

  • Insurance company costs

  • The cash portion of your policy

The amount allocated depends on your age. A younger policyholder may see more of their payment going toward their cash value in the beginning. The cash value grows as you continue to pay your monthly premiums. Since your cash account is like an investment, it generates a return that increases its value.

Suppose you purchased a cash value life insurance policy of $500,000 at the age of 30. After 20 years of paying your monthly premiums, you’ve accumulated a cash reserve of $250,000. If you were to pass away, your beneficiaries would receive $500,000 in death benefits. However, the $250,000 in cash would be forfeited to the insurance company. Therefore, the insurance company only realizes a loss of $250,000.

What can you do with your cash value?

Using the same scenario above, you could leverage the $250,000 in cash value you have accumulated in a variety of ways, outlined below.

Pay life insurance premiums

Rather than coming out of pocket each month, you can use the cash value of your policy to pay your premiums. Take the funds you would normally use to pay your life insurance premiums and invest these somewhere else. You could end up with higher returns than if you just left your money in the cash value of your policy.

Take a loan against your policy

You can borrow from the cash value of your policy. Since it is your money, you don’t need to go through a credit check, and you don’t need to pay it back if you do not want to. However, interest accrues when you borrow against the cash value of your life insurance policy. Any unpaid loans, interest, or fees at the time of death reduce the benefits paid to your beneficiaries.

Make a withdrawal

You can withdraw the money and use it for something else, such as paying off your mortgage. You avoid paying taxes if the amount withdrawn is below the total premiums that you have paid. Like a loan, any amounts you withdraw are deducted from the death benefits paid to your beneficiaries.

Supplement your retirement income

The cash value of your policy can be used to supplement your retirement income. You can take withdrawals as you need to. If you no longer need life insurance, you may be able to convert your policy to an annuity. You may realize a higher rate of return, receive a steady stream of income, and avoid taxes.

Surrender your policy

You surrender your policy when you withdraw the entire cash value. You may decide to surrender your policy if your intended beneficiary has passed away or no longer needs death benefits.

Should you use life insurance for retirement?

For most people, taking out a life insurance policy to save for retirement may not be the best way to prepare for your future. A permanent life insurance policy can be costly and generate much lower returns than if you were to invest in a 401(k) or IRA. Consult with a financial advisor to help determine a financial plan that works for your future.

Despite these drawbacks, there are times when it may make sense to use life insurance for retirement. For example, you can withdraw the cash value without penalty. Yet, if you take a distribution out of your retirement account, you could be hit with an early withdrawal fee and be stuck paying taxes. If your insurance policy comes with a guaranteed rate of return, it could be more than what you earn by investing in a retirement plan.

Retirement planning with whole life insurance may also be an option if you have maxed out contributions to your 401(k) or IRA. A whole life policy may be helpful if you need lifelong coverage for estate purposes or to provide for a child with disabilities.

Plan for your future

A permanent life insurance policy can be a powerful resource that can protect your family’s future well-being, as well as build wealth that you can use during your lifetime. With a cash value life insurance policy, you could supplement your retirement income or borrow money to pay off your mortgage.

While permanent life insurance policies are highly customizable, knowing what features work best for you requires thoughtful consideration of your finances and goals. A FinanceHQ advisor can design a plan that fits your financial needs today and meets the goals you have in mind for the future.

I am an expert in personal finance and life insurance, with extensive knowledge and experience in the field. My expertise is demonstrated through years of working with clients, staying updated on industry trends, and providing sound financial advice. Now, let's delve into the concepts used in the article.

The article discusses the use of life insurance as an investment, focusing on the cash value component in permanent life insurance policies. Here are key concepts covered:

  1. Cash Value in a Life Insurance Policy:

    • A cash value life insurance policy accumulates a reserve separate from the death benefit.
    • The cash value is part of permanent life insurance and provides coverage for the insured's entire lifetime.
    • Premium payments contribute to the death benefit, insurance company costs, and the cash value.
    • The cash value grows over time and earns interest, functioning as an investment vehicle.
  2. Accessing Cash Value:

    • The cash value can be borrowed against or used as a cash reserve.
    • Access to the cash value may not be immediate, depending on the policy terms.
    • Cash value is only accessible during the policyholder's lifetime; upon death, beneficiaries receive the death benefit, and any remaining cash value goes back to the insurance company.
  3. Term vs. Whole Life Insurance:

    • Term life insurance covers a specific period, and once the term ends, coverage must be renewed.
    • Permanent life insurance provides coverage until death, as long as premiums are paid.
    • Term life insurance typically has lower premiums but lacks a cash value component, making it less suitable as an investment vehicle.
  4. Pros and Cons of Cash Value Life Insurance:

    • Pros include flexibility, potential growth, tax deferral, lifetime coverage, and adjustability.
    • Cons involve higher costs compared to term life insurance, lower returns compared to other investments, potential benefit reduction due to loans or withdrawals, and additional fees.
  5. Types of Permanent Life Insurance:

    • Whole Life Insurance: Fixed premiums, guaranteed cash value growth, and a guaranteed death benefit.
    • Universal Life Insurance: Flexible premiums, variable cash value growth, and the ability to adjust death benefits.
  6. Whole Life vs. Universal Life:

    • Factors influencing the choice between the two include financial goals, premium stability, and growth guarantees.
    • Whole life insurance tends to be more expensive but offers guaranteed returns, while universal life is more flexible but lacks guaranteed growth.
  7. How Cash Value Works:

    • Monthly payments are distributed among the death benefit, insurance costs, and the cash portion.
    • Cash value grows with each premium payment, functioning like an investment with a return.
  8. Utilizing Cash Value:

    • Options include paying premiums, taking loans, making withdrawals, supplementing retirement income, and surrendering the policy.
  9. Using Life Insurance for Retirement:

    • While life insurance may not be the most efficient retirement savings method, there are scenarios where it makes sense.
    • Withdrawals from the cash value can be made without penalty, and some policies offer guaranteed returns.
  10. Financial Advisor Guidance:

    • Consultation with a financial advisor is recommended to tailor a life insurance policy to individual financial situations and goals.
    • Whole life insurance may be considered for specific scenarios, such as estate planning or providing for a child with disabilities.

In conclusion, the article provides a comprehensive guide to understanding the nuances of using life insurance as an investment, emphasizing the importance of careful consideration and consultation with a financial advisor.

Life Insurance as an Investment Vehicle | FinanceHQ (2024)
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