Life insurance is usually seen as a protective vehicle that allows your family to continue on after unexpected circumstances because you’ve given them income. It provides a death benefit that can help transition everyone to their new normal.
Thinking about life insurance as an investment seems out of touch with that reality, but it is an idea from which some people benefit. If you pay into a whole-life policy for 20 years, one that offers high cash values and low loads, then you have an income option. You could take your investments from that time, turn them into an immediate payout annuity, and receive a monthly guaranteed amount.
Are the returns great with this option? Not always. When Steve Parrish wrote about his experience with life insurance as an investment for Forbes, he reported a 6% return. Some investors can achieve that figure in one year with a standard investment strategy.
If you are thinking about diversification, then the pros and cons of life insurance as an investment are worth considering. When you still have a family to protect, then the death benefit should be a higher priority.
List of the Pros of Life Insurance as an Investment
1. Life insurance can give you a guaranteed investment return.
When you decide to pursue life insurance as an investment, then there is a guaranteed return that you’ll receive with most policies. If you use after-tax money to fund this effort, then you can often avoid the complicated taxation rules that happen if you turn the policy into an annuity structure. Most plans will offer somewhere between 0.5% to 2% annually as a return, although there are some options (that cost more) that could produce yearly returns as high as 6% to 8% on a robust trading year.
2. It provides you with a fixed premium.
If you want to add life insurance as an investment in your portfolio, the whole life or universal life are your two best options. In the former policy, your premiums are fixed for the life of the policy. You always know what you must pay to keep it active. When you build enough value into it, your monthly payments could take care of the premium amount for you, effectively giving you a death benefit and other advantages for free.
The latter option gives you more flexibility. Universal life insurance gives you the option to adjust your premiums and death benefits over time. It is also a whole life policy, but with different choices you can make.
3. Your policy develops a cash value that no one can take away.
When you use whole life insurance as an investment vehicle, then the money you’ve paid into the policy is yours to keep. This advantage stays in place even if you stop paying the premiums, although you would lose some rights and privileges if you stopped paying the premium. The cash value of your policy rarely equals the payout of your death benefit, but it could be a healthy amount to consider if you’re thinking about a career change in the future. Many professionals have put in their 20 years, earned a pension, and then used their life insurance as an annuity to supplement that amount while they try something new.
4. Any loans or use of the life insurance can go against the death benefit.
Let’s say that you need $50,000 right now because there is a home project you want to complete. If you have that amount in your life insurance policy or can take out a loan from it, then you have immediate access to that money. There are usually no strings attached to it either. If you can’t repay the amount (and your repayments with interest go back into your account anyway), then anything left outstanding if something unexpected happens goes against the death benefit.
If you had $500,000 in benefits to be paid to your family, then they might get $450,000 instead. Although that is a significant drop at 10%, the other $50k is already in use handling other business.
5. It forces you into the habit of saving money for a later date.
Over 40% of Americans today don’t have enough money in their savings account to cover one missed paycheck. The reality of modern wealth is that most families, including those making an income of over $100,000 per year, are living paycheck-to-paycheck. If you decide to use life insurance as an investment, then you’re forcing the issue of your savings. You must pay the monthly premium to keep the policy active.
Does it accumulate at a high rate? Probably not, but at least you’re receiving some accumulation instead of none. Instead of trying to time the market or experimenting with several different investment choices, an under-performing bond portfolio under the protection of life insurance does make sense.
6. You can avoid the capital gains tax with most life insurance policies.
If you decide to use life insurance as an investment, then one of the tax benefits is that you can avoid the capital gains tax on the income you receive. This option is possible because you’re investing after-tax money in ways that are similar to a Roth IRA. What is unique about this option is that you can also sometimes invest pre-tax money, which then relies on your tax bracket at the time of withdrawal.
You’ll lose this advantage if you decide to abandon or surrender your policy before it reaches its maturity date. Once you get past that deadline, then the current tax law does not apply capital gains rules to you when using American policies.
7. Life insurance policies don’t restrict your contributions.
When you start saving for your retirement, you’ll quickly discover that there are caps in place on the amount you can put into protected accounts. Some of those figures are quite low, like with an IRA. Even most 401(k) or 403(b) plans let you save less than $20,000 per year unless there are special exemptions that apply to your income. When you decide to use life insurance as an investment, then those contribution limits disappear.
As long as you can afford the monthly premium, then you can have whatever level of protection the insurance salespeople are willing to provide. You might even have the option to contribute extra cash into the plan so that it can build its wealth faster.
List of the Cons of Life Insurance as an Investment
1. Life insurance takes a lot of time to build cash value.
When you make the first premium payments for your whole life insurance, the policy will not have a cash value at all. It may take 3-5 years before it begins to build, whereas you could invest the amount you are spending on it directly into mutual funds to generate immediate returns.
Even when you take a 10-year financial period that compares life insurance investments to mutual funds, the amount earned is always going to be better in the latter. You’d end up with about 20% more by using straight investments when compared to paying your policy on time each month.
2. The premiums for life insurance are expensive in this area.
You can expect to pay about $3,500 per year into a whole or universal life policy if you’re using this vehicle as an investment. That’s less than the maximum you can put into an IRA, so there are some benefits there to consider. When you look at the monthly payments and what you receive for them, you’ll need to plan for at least 15 years of wealth-building before you can come out even with a significant cash value.
Paying $3,500 15 times in a row is money that adds up. Even if you have investment guarantees, there is an excellent chance that inflation will be higher than your return, so you’ll end up losing value instead of gaining it.
3. This investment format can be complex and challenging to understand.
If you are a young investor with limited levels of free cash for investing, then life insurance as an investment might not be the best option. Your primary goal in this situation should be to cover unexpected expenses, so term life insurance is a better option. You will be in a better financial situation by paying the cheaper premium and investing your savings into mutual funds or creating an emergency account that lets you manage household expenses.
The rules and regulations of using life insurance as an investment can be complex, and it is up to you to learn all of the rules. If you don’t work in the financial sector, then it might be wise to wait on this option until you can see what all of your choices will be.
4. Fees are high on life insurance policies that get used as an investment.
Although you don’t pay the fees of a whole or universal life policy directly, you are going to be receiving lower returns because of them during the initial years of the plan. The commission on a standard policy used for investing is usually 100% of the premiums for the first year, and then 6% of them for every following 12-month period. The money going to administrators is not being invested on your behalf.
That’s why a term life policy is a better investment for younger families since the commission is only 50% of the first year’s premiums. Then it is only 4% of them after that, which means you have more money available for tangible investments, albeit outside of the security of an insurance policy.
5. Life insurance as an investment forces you to use a middleman.
Think about what the insurance company provides on your behalf. It is going to take your monthly premium, pocket the profits, and then put a specific percentage of that amount into a pool to pay benefits. The rest gets invested into a conservative portfolio, such as bonds, so that the risk of loss is minimized to the greatest extent. Since that is the case, some investors prefer to invest in bonds directly instead so that there is no profit-sharing required before a payout.
That’s why you must look for no-load options if you pursue life insurance as an investment in every circumstance. If it doesn’t have that feature, then you need to pay for the privilege of investing your money with them while also paying for the insurance portion of the policy.
6. If you receive a “projected amount,” expect the return to be closer to the guarantee.
If you decide to use life insurance as an investment, then it will take between 8-12 years for your money to reach the break-even point. You’re taking a long-term gamble on your health as a way to make money. It makes sense from a diversification standpoint, but it might be a challenge for someone closer to retirement. When you shop for these policies, you’ll see a projected amount and a guaranteed figure that comes from your investment.
Pay attention to the second figure because your returns are much more likely to be closer to that amount. If the policy issuer won’t provide a guarantee, then you should run away from that opportunity as fast as your legs can go.
7. You only have two ways to get money out of your policy.
Since life insurance as an investment uses the same options as any other investor (stocks, bonds, mutual funds), they can be cashed out at any time the market is open. If you invest individually, then you can change where your money goes or use the cash for living expenses without any hassles. The same isn’t true if you’re working with a policy.
There are two ways for you to take money out of a whole life insurance policy. You can surrender it, but that requires at least 15 years of activity before you reach a point where it is profitable to do so. You can also borrow money from it, but then you might need to put more money back into it to keep it active. The reality of this investment is that you lose liquidity and receive no compensation for that decision.
8. You probably don’t need the tax benefits from this investment option.
When you speak with salespeople about having life insurance as an investment, one of the first benefits pointed out to you involves the tax-free nature of loans from the policy. Since most people use after-tax money for that amount, it would be that way – just like it is with a Roth IRA. Death benefits are also free from taxes, so that provides a way for the wealthy to avoid estate taxes.
Unless your net worth right now is over $10 million, you don’t need to worry about the tax implications of your overall wealth. Even if you begin to get close to that figure, trusts and gifts can reduce the size of your estate.
9. You face the risk of receiving a 0% return in some years.
Many salespeople promote the idea of life insurance as an investment because it can eliminate the risk of a loss. If the stock market indexes go down for the investing year, then you’d receive a 0% return instead of the loss percentage. That seems like it would be a good thing, and it markets well with people who love guarantees. When you factor in the cost of inflation over that 12-month period, it is essential to remember that you’re still losing value.
When the market has an up year, then you won’t maximize the gain. There are caps and percentages in place that allow the insurance carrier to push their profits at your expense. If the stock market index gains 16% and you have a 50% cap with participation quotas and other restrictions, you might receive 4% to 8% instead. If you were privately investing, you could double that figure.
10. Participation rates are variable in these life insurance policies.
Some policy providers restrict participation levels in their life insurance investment vehicles as a way to boost their profits. Even if your provider doesn’t place this limitation on your policy, the rate of participation in the plan can vary annually. That means your returns as a percentage of growth become unpredictable.
Let’s say that your life insurance provides a return based on 100% participation, a cap of 8%, and offers a no-load 0% guarantee if the market loses money. If you have full participation in the plan and the market gains 10%, then you get an 8% return. When your participation rates are at 50%, then you’d receive a 4% return on the 10% overall gain. Those differences can add up to a lot of lost money when you track it over a 10-year period.
11. Most life insurance policies in this area don’t count on dividends.
If you are fortunate enough to invest in a life insurance policy that is willing to take some risks with stocks, then you should be aware that dividends are not counted as part of the valuation. Since one-fifth of the market returns that happen each year come from these distributions to shareholders, you could be losing out on a significant portion of cash on any given year.
Let’s go back to the example above with a market that gains 10%. Now let’s say four percentage points are due to the issuance of dividends, so that means the actual credited return becomes 6%. If you’re at 50% participation, then you’ll see 3% come back to you. If inflation that year is 3.5%, then you lose value while the insurance company still sees a boost in their profit margin.
12. You can usually earn more using a straight index.
Most of the life insurance policies that investors use to grow wealth peg themselves to the S&P 500. Since 1928, the index for this exchange earned returns of 12% or more in more than 40 different years. If you have a cap on the amount you receive from your investing, then you could be losing significant earnings by using this investment vessel.
Assuming that a 12% cap is in place on an indexed universal life insurance policy, you would have about 70% less value in your accounts using this option than if you’d made the save investments on your own or there was no cap on your policy.
If you are looking for a way to build wealth quickly, then life insurance as an investment is probably not the best option. It offers opportunities for diversification, but it will take you more than a decade to break even under most circumstances when accounting for inflation.
There are times when it can serve as an investment opportunity if you have 20+ years of planning ahead of you. Most people purchase policies as a form of risk management, using the death benefit as a hedge to provide income to survivors or generate liquidity to pay off debts.
Those observations apply to the average person. Wealthy families can use life insurance as a way to move funds while avoiding the severe consequences of gift, estate, and generation-skipping transfer taxes. That’s why it is essential to review all of the pros and cons of life insurance as an investment before deciding to pay for a policy.
Blog Post Author Credentials
Louise Gaille is the author of this post. She received her B.A. in Economics from the University of Washington. In addition to being a seasoned writer, Louise has almost a decade of experience in Banking and Finance. If you have any suggestions on how to make this post better, then go here to contact our team.