When it comes to life insurance policies – it's not only about protecting your life. Many experts recommend it as a low-risk investment, which offers guaranteed death benefit.
Sounds good? Not for everyone.
In this article, we will be looking at the advantages and disadvantages of investing in life insurance.
How Does Life Insurance Work?
The idea of life insurance is to provide financial support against the untimely death of the insured. They, on the other hand, must pay premiums so that the policy remains active. There are two main types of life insurance:
1. Term Life Insurance
The first type is term life insurance. As its name suggests, this cover offers protection against the death of the insured for a certain period of time, called “term.” The term is usually between 10 and 30 years. Usually, they are the cheaper option.
Let's see an example:
Emma has a $200,000 20-year term policy. Within this period she passes away and her family receives $200,000 as a death benefit. If she dies after the 20 years expire, the family will get nothing (For more examples, you can try our Life Insurance Calculator).
2. Permanent Life Insurance
The second type is known as permanent life insurance. The name indicates that this type of policy offers lifetime protection against early death. Some of them can even offer insurance after the age of 100 up to 120. There are different types of permanent policies: whole life, universal life, and variable life insurance.
Not only do they provide a person with longer protection but also have a savings component.
It can be used as an investment opportunity.
|Protects Your Family||Premiums Are Much Higher|
|Clear The Financial Mess||Fees And Charges|
|Can Make A Profit||Uncertain And Negative Returns|
|Cope With Retirement||Lack Of Flexibility|
|Numerous And Various Policies||Not Really Tax-Deferred
Advantages Of Investing In Life Insurance
The most important, naturally, is the protection it offers against premature death. The death benefit distributed to the family can help them overcome any emotional as well as debt issues.
Let's take a look in detail:
Protect Your Family
The death of a loved one is the most terrible event. Often we have to deal with situations like this. With life insurance, things can be much easier and can help you overcome this. Most people take out a life insurance policy with the idea of securing their families in case of their demise.
Indeed, the death benefit is secured and it will relieve your family until they manage to overcome this difficult situation.
Certainly, having bought life insurance will guarantee you more peaceful days and assurance that whatever happens tomorrow, your family will be protected.
Clear The Financial Mess
In many cases when a person passes away, the family has problems repaying their debts. You know that you inherit both the good and bad assets.
Fortunately, life insurance policies offer a protection against unpaid debts – the policy will cover all unpaid obligations. This includes personal loans, credit cards, and others.
Make A Profit
Permanent life insurance usually offers something referred to as a savings account – accumulation of cash value. This account, of course, has an interest rate. The earlier you purchase a policy, the better for you and the more returns it will bring.
Let’s not forget:
You can use the cash value to pay for missed payments in order to keep your policy active. You can also take out loans from it, covering different expenses and in times of pressing needs.
Keep in mind: you can also use the cash value to invest in stock, bonds or other markets.
Cope With Retirement
When people retire, their income decreases significantly. This could be a serious problem at first when you have to adjust your financial management.
But here’s the interesting thing:
By having life insurance, in particular, permanent life policy, you can rely on additional money. This money comes from the interest your cash value has generated. It's like savings account within a life insurance policy.
Numerous And Various Policies
When selecting life insurance there are so many different options to choose from. There are term policies, which offer coverage for a fixed period of time and lower premiums.
The good news:
Permanent life policies, on the other hand, offer an investment tool (a savings account) as well as lifetime coverage. The diversity is incredible and there is always something that can suit your needs.
Disadvantages Of Investing In Life Insurance
There is no free lunch. Every single investment has its good and bad sides. Having discussed the benefits, now let's see some of the negative aspects that go with life insurance.
High Cost And Fees
If you want to take advantage of the investment opportunity, you have to purchase a permanent life insurance. Only they offer customers the chance of a cash value accumulation. Therefore, the premiums are much higher (sometimes ten times bigger). In addition, there are plenty of fees and charges that you have to pay.
Unfortunately, a big part of the premiums goes to cover fees, for example – administration costs. Let's not forget the commission you owe the person who sold you the policy.
If you want to take out a loan from your cash value, you need to pay a cash surrender fee up to 10% alongside an interest rate.
Uncertain And Negative Returns
Insurance companies talk customers into buying life policies by promising certain, and usually high, returns. By accumulating cash value you earn an interest, which many companies promise to be higher than most savings accounts. Even though often policies go with a guaranteed minimum interest rate, the real return is not as high as that.
Well, it's very simple. There are many fees and charges imposed on your account. After they are deducted the return is far less than the guaranteed interest rate, let alone the promised one.
What's more, these “promised” returns will happen only if you wait for a certain period of time before taking money out, say 20 years.
One more thing on the downside is that, especially during the first years of the term, the chances are high that your returns will be negative. This is because often the fees and charges exceed the interest your cash value can generate.
Lack Of Flexibility
Unfortunately, life insurance policies do not offer much flexibility. Life is not static. Sometimes the more you predict, the fewer things happen the way you expected.
Can you predict an unfortunate event? A disease or an accident?
No, but you can be ready for this.
Having an Individual Retirement Account (IRA) or a 401(k) gives you the freedom to reduce the amount you pay in case you face financial problems. This will not affect your account and the money in it will still generate interest over time.
So where is the problem?
However, life insurance does not offer you that. If you miss a payment, the money will be taken out of your cash account (if it's a permanent life insurance). Of course, this will result in a decrease in your cash value. If there is not enough money in your account, or you have spent it on paying premiums, you might lose your policy.
Don't you have the right to face financial difficulties and delay a payment or freeze payments for a while? Life insurance will not put up with this if you want your coverage to remain active until the end of the term.
Not Really Tax-Deferred
Some life insurances boats with the fact that they are offer tax-deferred accounts. To some extent this is true. For example, whole life insurances, give you the opportunity to make tax-free “withdrawals” as well as to “grow” a tax-free savings account.
The first thing is that, though the growth of your cash value is exempt from taxes, the premiums you pay are not. Unlike health insurance premiums, life insurance ones are considered personal expenses. The Internal Revenue Service (IRS) imposes taxes on personal expenses.
What is a little bit tricky is that the “withdrawals”, for example, are tax-free but they aren't actual distributions? In fact, to take money out you have to borrow money from your cash value. You are the lender and borrower at the same time. But you have to pay an interest rate to your policyholder.
So, the equation is easy:
You don't pay taxes on these amounts of money but you have to pay an interest rate because you have borrowed the money. Can you imagine the rate to be higher than the possible taxes you have to pay on withdrawals? It's quite possible.
Another thing worth mentioning is that if you take out a lot of money, you might exhaust your cash value. Which, as you already know, can lapse the policy.
Before investing in anything, you have to be completely sure what you want to achieve – high returns, stable income or protection for your family. Only when you know what your expectations are can you choose whether to invest or not in life insurance policies.
In case you decide to do so, learn more about the different types of life policies and choose the best one. They all have their charm as well as potholes down the road.