Originally published on hubpages. I added the poll as I had one there also.
Is Life Insurance a Savings or Investment Plan?
Depending on who’s talking, you are likely to hear a lot different views on the financial benefits of a whole life insurance policy. It’s an investment. It’s a savings account. It’s your own personal bank. While all of these carry a smidgen of truth, they are inaccurate, if not downright misleading. However, a good whole life policy can and should be the cornerstone of a family’s financial plan.
First let’s consider the mislabeling.
Life insurance is an investment. Well, yes and no. Some life insurance policies do have an investment component. Most of the time this means the cash value is invested in a mutual fund. In such cases, the agent must hold a series 6 or series 7 license or sell securities along with a license to sell life insurance. Some might consider an “indexed” life insurance policy – one where the interest on the cash value is tied to a stock index such as the S&P 500. These do not require a securities license to sell. Personally, I consider them more of a gimmick than an investment.
Life insurance is a savings account. No. Just no. While there are similarities, the fact that the cash value in a whole life insurance policy can grow is about where the similarity ends. In fact, a good policy with a strong mutual insurance carrier that consistently pays a good dividend will more likely than not far outperform a savings account. However, a life insurance policy is not a savings account!
Life insurance is your own private bank. There are lots of detailed books exploring this concept. Some of the strategies are valid, if potentially misrepresented. These are based on the idea that you can borrow from your cash value with little or no hassle. This is true. You are then charged interest. The rate may or may not be competitive with other loans. Sometimes your cash value can continue to accrue dividends even though there is a loan against it. Even so, I find the practice of “banking” with your life insurance policy to be dubious. Feel free to disagree but be sure to take a hard look at the scheme before moving forward. Except for true emergencies, I contend your cash value is better left untouched until you are ready to tap the cash value permanently.
So, why should life insurance be a family’s financial cornerstone?
First and foremost, there is the reason life insurance should be purchased in the first place – to protect family members from the financial burden of an unexpected death. With funeral costs averaging about $10,000 these days, few families can take such a financial blow. Most families don’t have enough savings to live far beyond their next paycheck, much less cough up thousands for unexpected funeral costs. Even the most financially savvy family would have to dip into savings or liquidate some assets unless they have a rich relative… or life insurance.
At the most basic level, a life insurance policy will cover those unexpected costs, often with at least some money left over. Agents typically recommend enough life insurance on wage earners to cover a up to ten times or more of the wage earner’s current annual income. While this is not unreasonable, not every family can afford such a policy. For this reason, I recommend a budget approach to buying life insurance. Determine how much your family can afford for life insurance and use that money to cover every member of the family. Not only does this method provide for any unexpected loss but it also secures coverage at a time when, hopefully, every family member is insurable. Too often, health or other issues arise to prevent someone from obtaining coverage so I always advocate obtaining insurance coverage at the earliest possible age.
Beyond the basic level, additional coverage for income replacement can ease the financial burden due to the loss of a wage earner. This may mean a family can keep their home, children can continue their education beyond high school and the family can continue to live a relatively stable lifestyle. But that’s not all.
Why look for a mutual insurance company?
Buying the right insurance policy from a mutual carrier offers something no other financial product can – the ability to build additional cash value with dividends. This additional benefit is often how some justify calling life insurance a “savings plan” because like a savings account, the cash value grows over time. When dividends are added to the cash value it is similar to compounding interest as dividends are paid on the entire cash value of the policy. While growth tends to be slow, it can add up to a significant amount. I’ve seen policies accumulate cash values nearly four times the face value of the policy and more. While dividends are not guaranteed, cash value will continue to grow and, barring some financial disaster hitting the insurance carrier, you will never lose a dime. But wait! There’s more!
Policy Loans – The Good, The Bad, and The Ugly
Remember how some say your life insurance policy is like having your own private bank? In a way, this is true because the policy holder can borrow against the cash value with very little hassle. As this is basically a loan secured by your own money, no credit check is needed. You can take as long as you like to pay back the loan. No collector will come knocking at your door. Sweet. Right? Meh, maybe not so much.
While the above is true there are downsides. First, the interest you will pay will be significant. These days they could be in the range of 6-8%, but the rate is set by the insurance company. Also this interest accumulates by drawing down your cash value. In other words, if you borrow $100 at 8% and don’t pay in back in a year, the $8 will be added to your loan balance. You will be then charged interest on $108 and so on. An unpaid loan could (and sometimes does) devour all of the cash value in the policy. Worse, at some point, you will have a negative cash value. At that point your premium payments will go towards the loan balance until they no longer cover the gap. Then your policy will lapse. Note that the details may change depending on your insurance carrier but, generally speaking, policy loans should never be considered lightly. I recommend they only be used on an emergency basis and then make every effort to pay off the loan as soon as possible. So what happens if the insured dies with a loan on the policy?
Assuming the policy is still in force, i.e. has not lapsed, verified claims are paid at the full face amount (or more if the cash value exceeds the face amount) less any loans and/or interest accrued. This assumes no other charges apply. Generally there will not be outstanding charges but again, it depends on the policy, the carrier and the circumstances.
Anything else? Well, I’m glad you asked. Most life insurance policies today offer a variety of options, called “riders”, to enhance the basic coverage and allow the insured to customize the policy to their specific needs. Most of these add to the cost of the premium and are beyond the scope of this article, however there is one worth mentioning – the accelerated benefit. While this can go by other names and it varies depending on the insurance company, in essence, this benefit pays out a portion of the death benefit if the insured is diagnosed with a terminal illness. The amount paid out, along with any fees, will be deducted from the face value of the policy.
Again, there are pros and cons associated with this but the bottom line is, it can help protect a family’s finances if a family member is terminally diagnosed. These funds, though potentially subject to income tax, can be utilized for any purpose, including extraneous expenses, keeping up with bills, or even paying for alternative treatments not covered by health insurance. While this option should be carefully considered, it could literally be a lifesaver. Best of all, most insurance carriers offer this rider at no cost. At the very least it could ease some money worries associated with such a catastrophic event.
As you can see, the value of life insurance extends far beyond simply providing for a death benefit. Because a loss in any family can cause financial hardship, the death benefit should always be the primary consideration, however, when the budget allows, extending this basic protection is a sound decision. While building a solid financial foundation is prudent and desirable, protecting those assets should be a priority. Life insurance can both help build and protect a family’s assets. This is why your life insurance policy should be the cornerstone of your financial plan.
No matter what your answer, there is something for you in my new book “Life Insurance “Dirty Little Secrets” for Consumers Revealed!”. Even if you already have life insurance, there are things you should know. For those still unprotected, this slim volume answers those questions that keep most people from securing a solid, affordable policy. You’ll learn what to look for in an insurance company and a good policy to provide financial security for you and your family. Rather than being “sold” a policy, “Life Insurance ‘Dirty Little Secrets’ for Consumers Revealed!” empowers you to seek out and secure the coverage that best works for you.