What if I told you that I had an investment for you. You’ll invest every year and it will take you about 11 years to break even. You will start to see returns in 20-30 years, around 4-5% on an annual basis. You probably would reject my offer. What I just described are the characteristics of a whole life policy. Obviously a whole life policy also offers a death benefit, but in this blog post I’ll cover reasons why life insurance is not an investment vehicle - or at least a good investment vehicle.
No one buys life insurance purely for the returns, that’s why I don’t consider it an investment vehicle. People buy investments to get a return on their money, and they buy life insurance to get protection - usually of their future income. Life insurance is designed to replace an economic loss and should be used that way.
When you buy a whole life insurance policy, it generally takes 20-30 years for you to see a return on your “investment” or premiums. However many people don’t keep their policies for that long and never see the returns. In a study the Society of Actuaries found that 20% of whole life policies are terminated in the first few years and that 39% of all whole life policies are terminated in the first 10 years.
Many people who buy these policies never see any positive return on premiums paid into the policy.
In addition many people, including some life insurance agents don’t have a full understanding of how cash value life insurance policies work. Illustrations with various sets of guaranteed and non guaranteed figures are shown, which can often be confusing for everyone involved. Other factors such as loan provisions, dividends, participating vs non participating policies, recognition vs non recognition of dividends are factors most don’t really understand. My feeling is that if you don’t fully understand where your money is going or how an “investment” works,you shouldn't participate in it.
With term life insurance premiums are much cheaper than those of whole life insurance policies. For most people to get the amount of coverage they need to protect their family, they will need to buy a term policy as opposed to a whole life policy.
The other reason that term life makes sense for most people is that you probably need more coverage in your younger years when you have many working years left and more future income that your family might lose if you die. As you get older and into your retirement years you may not need any coverage if you have assets saved over years, or you may need a smaller policy to cover final expenses if you don’t have assets built up.
There are times when a permanent life insurance policy is the right type of insurance to buy. Let’s explore some situations when one might want to consider a permanent life insurance policy.
While most people buy term insurance that expires once their kids are grown, if you have a special needs child your situation is very different. In these situations you may want to consider a permanent life insurance policy that will leave money to take care of your child. Most people create a trust that the life insurance proceeds will go into, usually managed by a sibling or trusted friend or family member.
If your estate is large enough to be subject to Federal or State estate taxes than life insurance would be used to create liquidity, or money, for your heirs to use to pay estate taxes. This is especially important if a significant portion of your assets is in a business or real estate where it isn't easy to quickly get the funds to use for estate taxes.
Most people should buy a term policy that protects their future income for their family. If you have a need or want to buy a permanent life insurance policy, I suggest you buy a guaranteed no lapse universal life policy. This policy is a permanent life insurance policy that is significantly cheaper than whole life, since it isn't designed to build up cash value. The policy essentially acts like a lifetime term policy with level premiums.