Life Insurance as an Investment

People typically purchase life insurance policies to protect their loved ones financially. Life insurance policies provide a cash payout to named beneficiaries in the event of the policyholder’s death.

For this reason, life insurance is predominantly viewed as a risk mitigation tool. However, given the favorable tax treatment policyholders receive, some use life insurance to facilitate the accumulation of wealth. Savvy individuals commonly use life insurance products to optimize their investment plans.

However, there are some types of life insurance that are better for investment purposes than others.

At the highest level, there are two types of life insurance — term and permanent. Term life insurance is active for a specified period — generally, 10, 20 or 30 years. Permanent life insurance, which takes the form of either whole life, universal life or variable life, is active for the duration of the policyholder’s life.

Term life insurance is usually much cheaper than permanent life insurance, making it an economical option for younger people looking to gain some financial security for their loved ones as they establish themselves financially. Unfortunately, with term insurance, there is no equity associated with the policy.

When the stipulated term ends, the death benefit expires, and the insurance company is no longer obligated to provide you financial protection. All premiums paid over the life of the contract are an expense to you and income to the insurance company.

Conversely, with permanent life insurance, you pay higher premiums, but they are divided into two components. The first covers the cost of the policy’s death benefit. The second is a cash value reserve that belongs to you for as long as you live.

You can allow this money to grow, and it can grow on a tax-deferred basis. The funds can be borrowed against as a loan or it can be permanently withdrawn. Generally, permanent withdrawals of the cash value reserve result in a reduction of the policy’s death benefit, and taxes are levied on any accumulated earnings above the policyholder’s basis.

There are four different types of permanent life insurance. Comparing life insurance policies can help you determine which one is best for your financial needs.

Permanent life insurance policies are a better investment tool than term life, but first, you must determine which features you find most valuable in order to choose the best permanent policy for you.

There isn’t a single life insurance investment plan that is optimal for everyone. Each policyholder needs to establish a plan that caters to his or her unique investment objectives and tolerance for risk. That said, there are a few guidelines to consider when comparing plans.

Remember, these policies are types of permanent life insurance. For individuals that just want to purchase life insurance, without the cash value investment component, term life insurance is the best option.

Given the tax-advantaged nature of permanent life insurance, many people use these vehicles for more than just financial protection for loved ones — they also use it to accelerate their accumulation of wealth.

Unfortunately, using permanent life insurance to enhance investment performance is not wise for everyone. Many policy structures significantly limit growth potential, which can hinder long-term wealth.

There are also many other pros and cons to consider, including those outlined below.

All things considered, using life insurance as an investment is best for high-income individuals seeking to protect their loved ones while sheltering their income from high tax rates. With life insurance, they can achieve peace of mind and sidestep big tax bills.

However, the average-income investor faces too much opportunity cost by investing in relatively low-yielding life insurance products. They can achieve higher after-tax returns by investing directly in mainstream investments, such as publicly traded stocks, bonds and alternatives.