Life insurance is generally thought of as protection for dependents in the event of the untimely death of the policyholder. In effect, it creates an instant estate for the family to live off in the absence of the policyholder’s regular income. The past decade has seen shifts in thinking toward life insurance as the insurance industry strives to reinvent itself to grow and increase its profitability while remaining relevant to its customers. The result has been the use of certain life insurance policies, particularly whole life policies, as investment strategies in addition to sources of death benefits.
Term and permanent are the two categories of life insurance policies. Term policies are only in effect for up to thirty years and must be renewed if the policyholders outlive them. They provide only death benefits. Permanent policies include all policies that don’t expire, meaning that the policyholders cannot outlive them as long as the premiums have been paid. Universal and indexed universal insurance and whole life insurance are included in this definition.
Whole life insurance policies, while providing a death benefit, add a savings component called a cash value. The cash value is the part of the policy that earns interest. This money can be withdrawn or borrowed against and even used to pay for the premiums if the amount grows large enough. In addition, the interest that accumulates is tax-deferred and the loan doesn’t have to be repaid as long as the total outstanding loan amount does not exceed the cash value of the policy.
When applied to whole life insurance, the word straight denotes a policy in which the death benefit remains in place for life as long as the premiums are paid. The payments never go up regardless of the age or the health condition of the policyholder.
These kinds of policies offer some very attractive advantages, including:
As good as the benefits look on paper, whole life insurance has some serious drawbacks including:
If the policy is being used purely as an investment strategy, there is no guarantee that the cash value will accrue at a predetermined rate without careful planning and guidance.
There are also other types of policies, such as variable universal life insurance, that offer cash value options. As with any policy, proper planning involves researching variable universal life insurance pros and cons.
When a policyholder is able to pay more than the minimum premium amount into the policy, the result is an overfunded policy. This can occur as happenstance or if the intent is to overfund the policy so that tax-free loans can be made against it. As tempting as it may be to use the overfunded amounts for tax-free loans while knowing that they don’t have to be repaid, this plan should only be carried out carefully and under the guidance of a skilled financial advisor. A whole life insurance policy owner does not wish to get to the point when the death benefit is needed but the policy has been prematurely depleted.
Investing in whole life insurance gives the policyholder flexibility and complete control to access the cash value at any point without penalty and to overfund the policy at will. A 401k offers the complete opposite. Money can’t be taken out without fees and taxes, the amount that can be put into the 401k is limited, and the investment opportunities are also limited by the controller of the 401k account.
That doesn’t mean that investors should have to choose one or the other. Both plans can be part of a wealth-building strategy as long as each one is funded so that risks are minimized and the greatest advantages are gained.
Even though whole life insurance provides many benefits, it can be out of reach for many people because of the high premiums and the length of time it takes for the cash value to accrue to a serviceable level. On the other hand, it can be the perfect option for someone who needs long-term protection, estate liquidity, and a guaranteed savings account. It is often recommended for business owners and those who have more cash to invest. Under those conditions, whole life insurance is a good investment.