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Life insurance is a way to provide for your loved ones after you pass. But one type of life insurance can also be used to invest. Cash value life insurance, a form of permanent life insurance, provides a path to accomplish two objectives at once: It accrues cash value that can earn capital gains as an investment, and it pays out to your dependents if you die while the policy is active. You can also tap into your cash value account to invest, pay policy premiums or take out a loan.
By contrast, term life insurance—the other main type of life insurance—isn't considered an investment because it only pays out after your death and doesn't include a cash value component.
Let's take a closer look at using life insurance as an investment, how cash value insurance may factor into your portfolio, and whether there are better ways to invest.
How Does Cash Value Life Insurance Work?
Permanent life insurance, which includes whole and universal life insurance, accumulates cash value in an account that acts as a savings account. A portion of your premiums goes into your cash value account, and that money grows tax-deferred over time. That means you won't owe taxes on your gains until you withdraw funds. All of your interest stays in the cash account, and it can compound and earn even more interest in the future.
Because of its cash value component, permanent life insurance comes with substantially higher premiums than term life. For example, a healthy 35-year-old man might pay around $29.97 in monthly premiums for a 20-year, $500,000 term life policy. However, the premium jumps to $571 per month for a $500,000 permanent life insurance policy.
How Different Cash Value Accounts Accrue Wealth
You can choose from three permanent types of life insurance, each of which differs in the way the cash value accumulates:
- Whole life insurance: With whole life, your monthly premiums are fixed, and the death benefit is guaranteed. Cash value grows at a minimum guaranteed rate, typically ranging from 1% to 2%. While the growth rate is slow compared to other investment types, you can grow a substantial sum over the long term.
- Universal life insurance: Some universal life insurance policies allow you to adjust your death benefit and lower your premiums if your cash value account has enough funds to cover policy costs. Indexed universal life insurance policies can tie the growth of your cash value to a stock index, such as the S&P 500. For its part, variable universal life can offer investment options from which to choose.
- Guaranteed issue life insurance: The coverage amounts for guaranteed issue life insurance are lower, typically less than $25,000. Consequently, the potential for cash value growth is also lower.
Is Cash Value Life Insurance a Good Investment?
On its face, cash value life insurance is not considered a good investment compared with some traditional investment alternatives, such as the stock market and traditional retirement plans.
Since cash value accounts grow with guaranteed rates of around 1% to 2%, it can take 10 years or longer to break even with your contributions. On the other hand, you might earn five times that rate by investing in the S&P 500. For nearly a century, stocks of large companies have generated an average annual return of more than 10%.
Of course, past performance does not predict future results, and the stock market's rate of return isn't guaranteed. Consider your risk tolerance before choosing an investment option.
Retirement accounts, such as 401(k) plans or IRA accounts, also have higher returns than permanent insurance. According to recent data from Vanguard, the average retirement account that's split evenly between stocks and bonds earns an 8.7% annual rate of return. Again, that's a substantially higher rate than the 1% to 2% range you might average with a cash value life insurance policy.
Since the IRS limits how much you can contribute to your IRA, 401(k) and other retirement plans, it may make more sense to invest in cash value insurance only when your traditional retirement contributions are maxed out.
Accessing the Cash Value in Your Life Insurance Policy
You can withdraw money or take a loan from your cash value account for almost any purpose, including:
- Emergency expenses
- Other investments
- Supplemental retirement income
- Premium payments
- An inheritance for loved ones
Considering the low growth rate of cash value life insurance policies, you may consider withdrawing or borrowing from your cash value account and using the money to make other investments. Bear in mind, though, tapping the cash value of a life insurance policy for other investments could reduce your policy's death benefit.
Another risk of using your cash value funds for other investments is you may be sacrificing guaranteed gains. If you're using the funds to invest in the stock market, your returns could fluctuate, and your investments could lose value.
If you've built up a large cash value, you might consider using it to cover the policy's premiums and invest the money you would have paid toward premiums elsewhere. Keep in mind, though, if you deplete the cash value account, your policy may lapse, and you could lose your coverage altogether.
You can also end, or "surrender," your policy if you don't need it any longer and want access to its cash value. In this case, you'll receive the cash balance in your account minus any surrender charges.
What Are Alternative Ways to Invest?
If you need financial protection for your loved ones but you're unsure about buying life insurance as an investment, consider enrolling in a term life insurance policy. Since term life policies don't offer a cash value component, they're more affordable than permanent life insurance. You can then take the amount you would save and direct it toward more straightforward investment methods, such as:
Enrolling in Your Employer's 401(K) Plan
Investing in an employer-sponsored 401(k) retirement plan is a smart and easy way to invest in your retirement. Your employer automatically deducts your contributions from your paycheck and deposits the funds into your 401(k) account on a pretax basis. Your funds then grow tax-deferred until you begin making withdrawals. Many employers match contributions up to a specified percentage of an employee's salary. It's generally advised to contribute at least enough to your 401(k) to meet your employer's maximum contribution—after all, it's free money. You can fund any amount you like, up to the IRS 401(k) contribution limit.
Opening an IRA
Individual retirement accounts (IRAs) are another excellent alternative to investing in permanent life insurance. Many banks, credit unions, online brokerages and investment companies offer IRA accounts.
The two main types of IRAs are traditional IRAs and Roth IRAs:
- Traditional IRA: You contribute funds with pretax dollars, lowering your taxable income each year you contribute. The fund grows tax-deferred until you begin taking withdrawals in retirement, and taxed as current income after that.
- Roth IRA: With Roth IRAs, your contributions are made with after-tax dollars, so you won't be able to deduct it on your taxes. Money in the fund grows tax-free, and you can withdraw the money without owing taxes or penalties starting at age 59½.
Investing in Stocks and Bonds Through a Brokerage
If you're already contributing to retirement accounts, you might consider investing in stocks and bonds using a brokerage account.
You have several ways to invest, depending on your level of market expertise and the level of advice you seek.
- Online brokerage: Online brokerages, such as TD Ameritrade and Fidelity Investments, are a good option if you don't mind doing your own market research and monitoring your investments yourself.
- Robo-advisor: Robo-advisors are digital advisors that recommend investments and manage your portfolio using algorithms based on your goals and risk tolerance. Since you aren't meeting in person, fees for robo-advisors are typically lower than financial advisors. You might opt for a robo-advisor if you're not comfortable managing your investments and want to limit fees.
- Financial advisor: Financial professionals can help you create an overall investment strategy, recommend investments and track portfolio results. Generally, you'll meet in person, and they may recommend investments and track your portfolio's results. This is typically the most costly option, but may be worth it if you are inexperienced, have a significant amount of money to invest or are simply more comfortable working with an experienced professional.
The Bottom Line
A cash value life insurance policy may be a good investment if you're already maxing out your 401(k) or IRA account. If you have a sizeable nest egg, a cash value policy can diversify your portfolio while providing you with permanent life insurance. It may also make sense if you're risk-averse and can be satisfied with lower returns than traditional retirement investments.
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