Benjamin Franklin said it first: nothing in life is certain but death and taxes. However, he neglected to note that both of those play a role in determining whether a life insurance policy is right for you.
Life insurance is the type of insurance that pays a death benefit to your beneficiary if you die while the policy is in force. And for term life insurance, that is pretty much all it does. Permanent life insurance — the other main type of policy — does that, too, but also features a tax-free savings component. Is either of these types of policy worth it? Is life insurance a good investment?
Is life insurance a good investment?
The answer depends on your circumstances. If you have dependents, a life insurance policy can give you the peace of mind that comes with knowing your loved ones will be cared for in the event of your death.
Permanent life insurance can also be part of a tax-deferral financial strategy that is intended to avoid paying taxes on savings until you are in a lower tax bracket, presumably when you are retired. 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 vital role in protecting your money.
But although life insurance can be a part of your investment plan, it should never be the whole thing. Remember: the primary goal of life insurance isn’t to ensure tax-deferred savings; it’s to protect your loved ones in your absence.
Benefits of life insurance
Is it worth paying premiums every month for a payout that you won’t live to see? Is it the best way to defer taxes?
Provide peace of mind
As we’ve said, the primary purpose of a life insurance policy is so that you know your loved ones — your spouse, children, even a beloved friend — will maintain a comfortable standard of living if you should die. Both types of life insurance policies provide this benefit, and it’s the first reason you would purchase a policy. The death benefit isn’t designed to make your heirs rich; it’s to make sure that school tuition can be paid and food can be put on the table.
You will pay higher premiums if you have permanent life insurance, but one of the reasons for this is that a portion of that premium will be set aside in a savings vehicle for you. As long as you continue to pay your premiums, the policy will remain active, and your savings will continue to build, with interest added as it’s earned. The interest rate will be conservative — you won’t make as much as you might, for example, in the stock market. However, it’s a safe way to save money with little risk.
Borrow on your cash value
Once you have a nest egg built up in your permanent life insurance policy, after the first decade or so, you can borrow on that money if you need it. For example, if you’ve had your policy for 20 years, you may have enough accumulated to pay for your child’s college tuition. You’ll need to pay that money back eventually, with interest, or else it will be subtracted from your death benefit. But it could be an attractive option when you need an infusion of cash.
Alternatives to life insurance
For some, life insurance may not be a wise choice. These are normally individuals without dependents and who do not need to provide financial protection to someone else if they die.
But even then, it depends on your financial goals. Perhaps you’ve always wanted to endow a scholarship for a needy student at the university from which you graduated. Or you’d like to make a lasting contribution to the animal shelter where you found your beloved pooch. Even if you do not have dependents, there may be reasons to purchase a policy. It may allow you to leave a lasting legacy for a cherished cause.
But there are also other options for saving that may make more sense in your situation. If you are comfortable with risk, the stock market traditionally earns good returns for those who invest wisely. If you’re not stock-savvy yourself, a mutual fund or another vehicle will invest the money for you.
Some life insurance policies will pay out a portion of the death benefit if you get sick, but you may find more financial benefit from purchasing a long-term healthcare policy instead. This insurance type covers you for a chronic illness or disability, and will pay for nursing care and more.
If you are primarily concerned with paying off your home’s mortgage if you are ill or die, consider mortgage insurance as an alternative to life insurance. A good policy can protect you from default and pay your mortgage if you are incapacitated or die. It will also ensure that your heirs do not have to worry about monthly payments until the house is sold.
Frequently asked questions
Is term or permanent life insurance a better option?
Term life insurance is cheaper and has a single objective: to pay out a death benefit. For most people, it is a more effective option. A permanent policy, though, can play a part in a strategic financial plan. A financial advisor can help you determine what is best for your situation.
Should I have a life insurance policy if I have no children?
You may not need one if you have no dependents. Ask yourself: will anyone be financially inconvenienced if I die? If not, you may not need a policy right now.
Can life insurance help me to leave a legacy to my favorite charity?
Yes, it can allow you to leave a significantly larger financial stake to your beneficiaries than you might be able to afford otherwise. A term policy with a million-dollar payout, for example, may cost you a few hundred dollars a year if you are young and healthy.
Should I use my life insurance policy as my main savings account?
That’s probably not a great idea. You can earn a higher interest rate for your savings if you invest it in a well-managed, low-risk mutual fund. Depending on your risk tolerance, there are other options that can earn you a better return on your dollar. A financial advisor can help you determine the best choice.