Most people have a basic understanding of what life insurance typically is: a benefit to your family if you should ever pass away. However, there can be much more to life insurance than just a death benefit to your survivors. It might surprise you to find that the right type of life insurance can be a dynamic investment tool. It’s a little known secret that some of the savviest investors are using life insurance as an investment tool.
Before we get ahead of ourselves we need a foundation on which to build. Let’s start with a basic understanding of the most common types of life insurance; term and permanent life policies. There are many other variations and subtypes of life insurance, though only certain types are suitable for investment purposes.
Term Life Insurance
Term life insurance is a policy set for a certain period of time, and during that time frame the payments are fixed and do not change. Term life policies generally have the lowest monthly payments, but are worth nothing if the policyholder survives longer than the term. For example, if you purchase a 20 year term policy, and then pass away on year 21, there will be no pay out from the insurance company to your beneficiary. As a result, term life policies should not be looked at as an investment option.
Investors may see benefits, though, in using a term life policy as insurance on certain investments that could be dramatically affected by someone’s death. A small business is a great example, especially if that business carries debt. If the premium for a term life policy is paid out of after-tax dollars, then any death benefit is typically tax free to the beneficiary.
In short, term life can be an inexpensive way to ensure that the death of a loved one doesn’t have a negative financial impact for their family, or even to protect an investment that could be negatively impacted by the death of an individual, but it is not an investment tool.
Whole Life Insurance
Whole life is considered permanent insurance. This type of policy usually offers three things:
- A death benefit – The policy pays out a lump sum commonly called the death benefit to the designated beneficiary upon the death of the policyholder. This death benefit and the premiums are set at the time you acquire the insurance and the amount never changes.
- Cash value –The premiums you pay become the cash value of the policy. The insurance company invests this money and it grows over time.
- Lending Options – Most whole life policies allow you to take out loans. For example, you can borrow against your whole life insurance policy to buy a car, rather than getting a loan from a bank. When you pay back the loan, the interest is paid back into your policy, thus increasing the value. There is even an investment strategy built around this idea called “Infinite Banking.”
Universal Life Insurance
Universal Life is a variation of whole life insurance. It has many of the same features as a whole life policy, but it offers flexible death benefits and premiums, depending upon your life circumstances. For example, if you get a large bonus or commission, you can choose to put more money into your universal life policy. The main limitation is that increasing the death benefit may require an additional medical review. You can choose to have the death benefit equal a set amount, or be the cash value of the policy. The cost of universal life is generally lower than whole life. It also includes a cash value feature that acts like a money market account-meaning it grows at current market rates. Similarly to whole life, universal life can be considered an investment tool.
Accidental Death Insurance
This can be purchased as a rider in addition to other policies, or in some cases purchased as stand-alone insurance. It is typically inexpensive, because it only covers accidental death or in some cases dismemberment or permanent disability. It does not cover suicide or health related issues. If you participate in high risk activities such as skydiving or diving with great white sharks, you will most likely be declined or have your policy revoked. Accidental Death policies are not considered an investment tool.
Most life insurance policies take into account your age and tobacco use when determining your premiums. Additionally, most policies typically have a suicide clause that renders a policy void in the event the policy holder commits suicide, however, these are usually only in effect for the first two years of a policy.
There are many things to take into account when considering which life insurance policy is best for you. A trained professional can help guide you through the maze and maximize the benefits and investment potential of the different types of policies. When selecting a professional be sure that they are experienced, and are with a reputable long standing company. Remember, the relationship with the insurance company of your choosing may last a lifetime.
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