Key takeaways
- Life insurance policies come in many forms and at varied price points
- Life insurance can create a financial safety net for your family, loved ones or business partners
- Some types of life insurance can provide tax-deferred growth on a cash-value feature but are not comparable to traditional investment vehicles
- Term policies are often the most affordable form of life insurance
Although it may be uncomfortable to think about, life insurance can provide a valuable financial safety net. Policyholders pay into a life insurance policy during their life, and when they pass away, those they specified as beneficiaries receive the policy payout, also known as a death benefit. That’s the quick version of how life insurance works, but the details and varieties can be myriad. Understanding these policies’ ins and outs can help you determine when life insurance policies are worth it for you.
Is life insurance a good investment?
Life insurance policies are not well designed to serve as an investment tool for policyholders. Instead, policies primarily serve as an income replacement tool. In a less financially literal sense, a life insurance policy can be an investment in the financial safety of your loved ones because the policy’sdeath benefit can replace your income if you pass away. In short, policies are often intended as a way for loved ones to cover the cost of living if the primary income earner passes away. However, they are not typically seen as an investment vehicle for making a profit.
Some policy types, like permanent life insurance, can also be part of a tax-deferred financial strategy to help avoid paying taxes on savings until you are in a lower tax bracket, presumably when you retire. There are other ways you can do this, such as IRAs and 401(k) plans, but if you’ve maxed out your investment with them, life insurance can play a small role in protecting your money.
Benefits of life insurance
Life insurance can come in various forms and be tailored somewhat differently based on your needs and budget. Before deciding on a policy, it’s essential to consider the pros and cons ofthe different life insurance types to find the right coverage for your needs. Here are some of the benefits that make life insurance worth it.
Replaces your income
Life insurance can be used to replace the income you would have provided. Any type of life insurance policy can help provide this benefit, which is one of the main reasons someone would purchase a policy. The death benefit can help ensure that other responsibilities — such as school tuition, mortgage payments and even basic expenses like bills and food — can be paid for even after you’re no longer around.
Leaves a legacy
Whether for your children or relatives, to continue a family business or donate to a favorite charity, you can use your life insurance death benefit to establish a legacy. Life insurance payouts can often be quite large, depending on the policy, and who receives that payout is up to the policyholder.
Relieves stress on loved ones
The death of a loved one and the responsibilities that follow are stressful. The stress is often made even more apparent when combined with the grief of loss. Having a life insurance policy — even a small one — can help make this time easier. The payout from a life insurance policy can provide the funds to pay for funeral costs, flowers, grief counseling and other services.
May accumulate cash value
You will generally pay higher premiums if you have permanent life insurance because the policy lasts your lifetime instead of expiring after a certain number of years. A portion of that premium will be set aside in acash value account. The cash value will continue to grow tax-deferred for as long as it remains in the policy. You can access the cash value via policy loans, but it could affect the death benefit amount that is paid to yourbeneficiary if you do not repay the balance plus interest during your lifetime. If you pass away before the loan is repaid, your death benefit will be lowered by the amount you owe, so your beneficiary will get a lower payout.
Whole life insurance offers a guaranteed interest rate, allowing the cash value to grow slowly.Universal life insurance has more flexibility and can potentially build interest faster, depending on your specific policy. Experts recommend consulting a licensed insurance agent to determine what’s ideal for your situation.
Payout typically avoids probate
Life insurance policies are generally not considered part of the policyholders’ estate and avoid probate, going directly to the named beneficiaries. Creditors are also usually unable to collect from life insurance payouts to negate the policyholder’s debt. That is because the payout belongs to the named beneficiaries, not the policyholder’s estate. This benefit can create a protective avenue of financial transference such that difficulties with one’s estate won’t prevent a life insurance policy from providing financial security to loved ones.
Drawbacks of life insurance
While many people can benefit from life insurance, it isn’t always the best solution for everyone. Here are some of the drawbacks of purchasing life insurance.
Life insurance might be expensive for some
The cost of life insurance depends heavily on your age, health, policy type and death benefit amount you choose. Young and healthy people typically get the best rates on life insurance. The older you are and the more health issues you face, the more expensive life insurance will generally be.
However, the high cost of coverage may be most noticeable with a permanent life insurance policy compared to a term life policy, which is typically much cheaper. In many cases, life insurance is less expensive than you’d expect, but price is certainly a consideration. You may need to speak with a licensed agent to determine if life insurance is worth it to you.
You may have to pass a medical exam
Many life insurance policies require a medical exam. The results of the exam may be used to determine if you qualify for coverage or how much coverage a life insurance company is willing to give you. However, you may be eligible for life insurance without a medical exam.
If you are facing severe health risks, you could even opt for guaranteed-issue life insurance. These options may be more expensive than the coverage you could get with a medical exam, but for some shoppers, they could be the best choices.
You may need to spend time educating yourself
When looking into life insurance, you may encounter lots of new vocabulary. For instance, there are different types of policies, benefits and riders to make sense of, which can make comprehending your coverage options difficult. Because life insurance is an important financial purchase, you may want to consult a financial expert to help you fully understand what you are signing up for.
Term life has an expiration date
Although term life insurance is typically the cheapest, if you do not pass away within the policy term, your policy expires with no payout to your beneficiary. Some companies offer the ability to renew your policy, although your new age and health status could affect the cost. Other companies offer the option to convert your term policy into a permanent policy prior to expiration.
You could also consider purchasing a return of premium rider, which means that if you don’t pass away during the policy term, you’ll get your premiums back when the policy expires. These policies are typically more expensive on a monthly or annual basis, though, so be sure to keep that in mind.
Buying both term and permanent life insurance
Many people may elect to purchase both term and permanent life insurance policies, with each geared towards different goals. For instance, someone may take out a term policy with a duration that matches their mortgage so that if they pass away before the home is paid off, their spouse won’t be left struggling to pay the remaining payments. To complement this, that same individual may purchase a small permanent life insurance policy to maintain as a form of final expense insurance. In this scenario, the term policy handles large and foreseeable potential costs, while the permanent policy covers the smaller costs associated with passing away.
Other options to consider besides life insurance
Life insurance may not be the best option for everyone. Although you should work with a licensed insurance agent to determine the best path, you might consider the following alternatives to certain aspects of life insurance policies:
- Investing in the stock market: If you are comfortable with risk, the stock market may be a good way to grow your wealth over time. This option is usually best suited for those who plan on holding their investment for an extended period of time, usually for 10 or more years. While you generally do have to assign a beneficiary to your accounts, the amount your beneficiary would get if you pass away is variable based on how your investments are performing.
- Certain health insurance policies: Some life insurance policies have living benefits that allow you to use a portion of your death benefit if you are facing a chronic, critical or terminal illness. You may also be able to access some of your death benefit if you need long-term care. Buying certain health insurance policies not attached to a life insurance policy may provide similar benefits. It’s worth it to compare features and pricing between health insurance plans and life insurance plans that have health-specific riders.
- Self-funding: If you have the ability to, you could choose to set aside money in a separate savings account for use in the event of your passing. This strategy can provide similar benefits so long as you’re diligent about making contributions and committed to not dipping into the money for other expenses.
- Max out retirement accounts: Generally, the benefits of using traditional investment vehicles like 401(k)s and IRAs will outweigh those of a permanent life insurance policy. If your annual contributions to such retirement accounts are already maxed out, it may become more beneficial to utilize permanent life insurance as a supplementary store of value.
Frequently asked questions
The best life insurance company offers the policy type you want, including the coverage and benefits that make the most sense for your situation. Once you determine your needs, gathering quotes from several carriers can help you figure out which one offers the best price. Bankrate’s analysis found that some of the best life insurance companies in various categories include Guardian, Mass Mutual, Nationwide, Mutual of Omaha, Northwestern Mutual, Prudential and State Farm.
If you’re deciding between term and permanent insurance, you may want to consider how the policies differ and what your needs are. Term life insurance generally works best for people who only want coverage for a set amount of time. Permanent life insurance, on the other hand, remains in effect for your whole life as long as you pay your premiums. Term life insurance is typically cheaper and could make sense if you only want coverage for a period of years — such as your kids’ childhood or as long as your mortgage remains in effect.
Whether you have children or not, you may want to consider purchasing a life insurance policy. If you have a partner who would be financially impacted by your passing, a death benefit could be helpful to them. If you take care of an elderly parent or sibling, you might look into life insurance for your family, which could help finance their care after your death. Even a business partner may benefit from your life insurance policy; it could help protect their finances and keep the business going. You could also opt to buy life insurance if no one relies on your income to help cover end-of-life medical expenses or funeral costs. Or, you could assign a charity or organization as your beneficiary so that you leave a financial gift upon your passing.
Most experts advise against using life insurance as your main savings account. Life insurance is not designed for the policyholder to withdraw money from; it’s meant to be there when you pass. Plus, you can typically earn a higher interest rate on your savings if you invest it in a well-managed, relatively lower-risk mutual fund. Depending on your risk tolerance, there may be other options that can earn you a better return on your dollar, too; the cash value in permanent life insurance policies doesn’t usually accrue at a very high rate. A financial advisor can help you determine the best choice for your individual needs.
