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How to use life insurance as an investment, not just a last resort

Money.com logo Money.com 6/15/2020 Paul Schrodt

There is, without a doubt, no type of insurance we like to think about less than life insurance. It’s a financial product that, by its nature, is geared toward answering questions of when and how you’ll die, possibly even prematurely—and, subsequently, how the nearest loved ones in your life will fare after you’re gone.

Life insurance can be a vital tool, helping mourning family members deal with the monetary impact when someone passes away. The payout from life insurance can mean the difference between your survivors struggling to get by and having a decent financial cushion.

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But life insurance doesn’t always have to be thought of as simply an unmentionable rescue package should the worst happen. It is, like any other type of insurance policy, a complex investment with its own pros and cons. And depending on how you select and manage it, life insurance can become a smart weapon in your overall financial arsenal.

As with any part of your financial life, early attention to your insurance needs is rewarded. “It’s common for people to approach life insurance with an ‘I’ll handle that later’ attitude,” says Marcy Keckler, vice president of financial advice strategy at Ameriprise Financial. “[It’s] a somber topic, and many people assume they will have time to sort out the details of coverage later down the road,” she says. But "you might be putting your loved ones at risk of having to cover financial obligations out of pocket if you continue to put it on the back burner.”

Keckler recommends thinking of life insurance “as an investment in your family’s financial future since it can play an important role in protecting your loved ones if you pass away unexpectedly.”

For instance, without the right life insurance, a spouse—particularly one who’s not working or not working at the same income level—might be overwhelmed by the hardships of individual expenses without their partner’s paycheck both in the moment and in years ahead. Even if someone else isn’t relying on your income, the extra earnings will be welcome.

Life insurance protects the contributions of each partner, even if they aren’t necessarily financial in nature. “A spouse who isn’t employed is likely doing many essential things to help the whole family—preparing meals, caring for children, running the household,” Keckler says by way of example. “Life insurance covering the non-employed spouse can provide needed resources to engage help to support the family with essential services in case of an unexpected death.”

If you happen to be thinking about widening your family with the addition of a child, it’s all the more imperative to think of the financial repercussions down the line by examining life insurance not simply as a last resort, but as a financial security.

So what type of life insurance do you want?

Many people might not realize that the types of life insurance differ significantly, and which your choose can have a sizeable impact on the relative financial reward you could gain from your policy.

Life insurance policies are widely broken down into two major types: what’s known as whole (or permanent) life insurance, and term life insurance. The former covers the insured for that person’s entire life, while term life insurance is tied to a particular length of time, meaning that you can only access a payout in the years that the plan is active.

But some deeper financial distinctions may matter to your own circumstances and investment strategy. Whole life insurance generally contains a cash value that the plan’s owner can access in addition to the death benefit. That advantage, though, comes at a cost: Premiums are for the most part much higher than those for term policies that offer corresponding coverage.

What’s the point of the added cash value inherent in a whole life plan? It’s the ability to more conveniently access funds, even if the plan holder hasn’t died.

“Down the road, if individuals decide to leverage the cash value during their lifetime, the payout will depend on the type of policy and how they take money out,” notes Brian Wash, certified financial planner for SoFi. “The most common ways people take money out of policies are: taking a loan from the policy, converting the cash value to an annuity [a series of regular payments], surrendering the policy, or leveraging riders such as enhanced long-term care benefits.”

In other words, while whole life insurance might look like a prized financial solution, it has its own drawbacks in the form of high regular costs.

“You will want to carefully evaluate the right approach for your financial situation and the needs of your loved ones,” in deciding between the options, according to Keckler. “In some cases, it can make sense to consider a combined approach, with some term life insurance and some permanent insurance.”

Wash points to another holistic strategy that combines term insurance with other investments that can yield higher cash benefits before an inevitable death.

“In general, buying term and investing the difference in the stock market has shown superior results compared to leveraging permanent life insurance due to the cost of insurance and relatively conservative growth of cash value,” he says.

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Still, Wash adds, permanent life insurance may suit “individuals with a lower risk tolerance.” But they should be sure to make the investment truly permanent. Which is to say, the possible advantages of a permanent policy will vanish if you don’t stick with it—you’ll simply have paid higher premiums for no reason. And raiding it for cash value while you’re alive nullifies the actual point of life insurance, which is to financially ease things in the case of your death. While no one may technically need whole life insurance, its fixed nature may provide comfort to some individuals.

Fine-tuning your choice

Whatever plan type you opt to buy, you’ll want to closely inspect how the details of particular plans meet your needs and desires.

Start by considering any coverage you already have, such as that through your job. While the free life insurance provided through an employer is welcome, the policy’s payout probably falls far short of what you need. And employer-based life insurance ends when you leave the job.

Life insurance is, more than anything else, an investment based on the fate of death, however hard to comprehend. When choosing a plan, “the general rule of thumb is to aim for 8-12 times your annual income, but this can vary based on your assets, debt, and family,” Wash advises.

If you do decide to go the permanent life insurance route, the “risks and potential investment returns can vary widely among different policies,” Keckler says. For example, variable universal life insurance often allows for numerous investment choices among different asset classes (such as equities, bonds, commodities, and property). And what’s known as indexed universal life insurance typically supplies returns that are bound to a specific investment index like the S&P 500, sometimes with a cap on what your return can be.

And always be prepared for things to change.

“Don’t just set it and forget it,” Keckler says of a policy. “Review your insurance coverage annually. As your life evolves over time, your insurance needs will likely change as well. Reviewing your coverage will help you determine if policies you currently own are still a good fit for you. It also may help you determine if there are policies you no longer need and identify any gaps in coverage.”

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