‘Is life insurance worth it?’ It sounds like a simple, “yes-or-no” question. But like so many things in life, the answer isn’t quite so cut-and-dried. The relative advantages and disadvantages of life insurance depend in large part on individual circumstances and objectives.
That is—whether life insurance is “worth it” depends on who’s asking the question.
For some people, life insurance is nearly indispensable—if you don’t have it, you’re exposing your loved ones to potential economic catastrophe.
For others, it’s a valuable financial-planning tool but more of a bonus than a necessity. And, of course, there are a few people who are better off without life insurance.
Part of the reason for the ambiguity is that there is more than one type of life insurance.
In fact, there are three distinct categories of life insurance—term life, whole life, and universal life.
Within each category, there are multiple variations. Different policies from the various top life insurance companies offer different benefits, and dozens of optional riders allow policyholders to tailor coverage to individual needs.
Certain policies and the many available riders have more relative value to some people than to others. It all depends on your current personal, family, and economic circumstances—along with your long-term financial objectives.
Is Term Life Worth It?
Due to term life insurance rates being so affordable for younger people, most financial advice focuses on the benefits of term insurance.
Term life insurance is a straight-forward concept sometimes referred to as “pure life insurance.” You make regular premium payments to the life insurance company over the course of a policy’s term (i.e., the period of years during which the policy is effective).
In return for paying your term insurance premium, the life insurance carrier promises to pay out the policy’s death benefit to your named beneficiary if you die during the term.
The purpose of term life is—in the event of the insured’s untimely death—to protect people who are financially dependent on the insured.
For instance, a term policy’s death benefit might protect an insured’s spouse and children against a big drop in household income (and resulting standard-of-living reduction) that would result from the insured’s passing.
Policy proceeds might be used to pay off a mortgage, ensuring that surviving family members still have a place to live.
Or, a policy’s death benefit might make sure a decedent parent’s minor children have ample funding for their education.
Death benefits can also be annuitized so that funds are received through regular payments (with interest) over an extended period of years.
Annuitized death benefits can be structured to correspond to the actual income loss, easing the long-term financial strain on a surviving spouse.
#1 Advantage of Term Life
The big advantage of term life is that it is relatively inexpensive, letting policyholders obtain high coverage amounts with affordable premium payments.
Check out the rates for someone in their 20s.
Depending on the specific insured, a term policy might provide several hundred thousand dollars’ worth of coverage for less than fifty bucks a month in premiums.
The chief downside is that, by definition, term policies eventually expire.
If you live through the term, you’ll eventually reach a point where you no longer have coverage.
Part of the reason term is so cheap is that the vast majority of term policies lapse without ever paying out.
Indeed, that’s the more desirable outcome because it means you’re still alive. But it also means you no longer have coverage. If you still need life insurance, that might be a problem.
In some cases, you can renew a term policy annually after its term expires. Or, you can just apply for another policy.
However, life insurance premiums get a lot more expensive as you get older, which can negate the main benefit of term (its affordability) if you still need coverage after a policy’s term expires.
Here are term insurance rates for someone in their 50s.
No Cash Value
Another noteworthy disadvantage of term life when compared to other forms of life insurance is that term policies don’t accrue any cash surrender value.
So, you either die, and the policy pays out a sizeable death benefit. Or, you outlive the term, and all the money paid for premiums is gone. Depending on your life outlook, you could call that a no-win proposition.
With that said, though, term life can be an excellent deal if your overarching concern is income replacement.
The ideal candidate for term is a young adult, has dependents relying on his or her earning capacity, and won’t need coverage after a finite period.
For fairly cheap premiums, term coverage ensures a dependable source of cash is available to protect your family financially if you die before a given date.
Young parents in particular often can’t afford the higher premiums necessary to obtain a cash-value policy with a death benefit sufficient to make up for the long-term loss of one spouse’s income.
Rather than going under-insured or foregoing life insurance altogether, a term policy offers affordable coverage until income replacement becomes less of an issue or you can afford the higher premiums for a permanent policy.
It’s worth noting that life insurance carriers have recognized that some potential policyholders are put off by the risk of outliving coverage and the likelihood of “throwing away” premium payments for a policy that never pays out.
With that in mind, companies have developed a couple policy options that at least partially obviate term life’s downsides.
A “conversion option” is language included within a term policy that gives the policyholder the guaranteed contractual right to convert term coverage to a permanent policy during the policy’s term.
Importantly, conversion options don’t require any additional underwriting.
So, if your health status worsens during the policy’s term, you can still obtain permanent coverage you might not otherwise be able to qualify for.
When the option is elected, premiums usually increase and/or coverage decreases, but the important thing is that you end up with a policy guaranteed to remain in place for life.
Return of Premium
For people who don’t like the idea of paying premiums for twenty years and receiving nothing tangible in return, some carriers offer “return-of-premium (ROP)” riders.
When an ROP rider is in place and the insured lives through the entire term, the insurance company refunds all premiums paid over the term to the policyholder.
Premiums are inevitably more expensive for an ROP policy but not obscenely so. In the right situation, an ROP rider can be a great deal and an attractive compromise between term and cash-value life insurance.
Conversion options and ROP riders are intended to make term policies perform a little more like permanent cash-value policies, which, of course, raises the question…
Is Permanent Life Insurance Worth It?
Permanent life insurance comes in two principle flavors—whole life and universal life (UL).
What makes them distinct from term coverage is that (1) coverage never expires as long as you pay the required premiums, and (2) policies accrue cash value.
Permanent insurance policies are structured so that, when you make a premium payment, the money is divided between the cost of the policy’s death benefit and a cash-value account.
Funds held as cash value usually earn compounding, tax-deferred interest.
Thus, cash value continuously builds through both premium payments and growth on the existing balance.
In most cases, a permanent policy’s cash value can be used as collateral for life insurance policy loans from the insurer, can be partially withdrawn, or can be withdrawn in full by surrendering the policy.
A policy’s cash value is a genuine financial asset (frequently described as “equity” in a life insurance policy) even if the policy isn’t ultimately surrendered.
For that reason, cash-value policies are useful for retirement planning, estate planning, and wealth-building generally.
Though the specifics vary between states, cash-value life insurance is normally protected against creditor claims and bankruptcy liquidation up to a certain value—making life insurance a good asset-protection tool, as well.
Of the two types of permanent coverage, whole life insurance is the more predictable and conservative.
Whole life premiums are fixed for life, and cash value earns interest at guaranteed rates.
Some whole life policies issued by mutual insurance companies are also eligible for dividend payments.
Depending on the company, eligibility for dividends can sometimes dramatically increase a policy’s growth potential.
In fact, it’s not hyperbole to say that, when evaluating the long-term performance of whole life, dividend eligibility can be a game-changer.
Universal life policies have a premium and benefit structure that is more flexible than whole life.
Subject to minimum requirements necessary to keep coverage in place, the owner of a UL policy can opt to pay higher or lower premiums—depending on current circumstances and long-term goals.
With higher premiums, more money is assigned to cash value, which, in turn, results in greater earnings potential. Policyholders can also choose to apply existing cash value toward premium obligations.
With a standard UL policy, cash value grows at an annual interest rate determined by the performance of the carrier’s investment portfolio (but subject to a guaranteed minimum rate).
Variable Universal Life (VUL) policies base cash-value growth on the performance of various investment options selected by the policyholder.
Insurers often offer dozens of different options that vary in risk / reward potential.
Strong investment performance can lead to impressive cash-value growth, but there’s also the risk of decreasing or stagnant cash value if the selected investments perform poorly.
A third UL option that has become very popular recently is called Indexed Universal Life (IUL).
Rather than selecting investments like with VUL, IUL policies link cash-value growth to a specific equity index, similar to indexed mutual funds. The S&P 500 is probably the most popular, but some carriers let policyholders choose from among several different indexes.
IUL policyholders can usually also choose to allocate a portion of cash value to a fixed account that grows at a guaranteed minimum rate.
IUL insurance policies typically include a “participation rate” (i.e., the percentage of the index’s growth that translates into policy growth) and/or a “growth cap” (i.e., a maximum rate of return).
For instance, if an IUL policy has a 70% participation rate and the equity index grows by 10% during the relevant period, the interest rate assigned to the policy would be 7%.
Or, if an IUL policy’s growth cap is set at 10% and the index grows by 15%, the policy’s return rate would be limited to the 10% cap.
In exchange for growth caps and participation rates, insurers guaranty that, if the index decreases over the relevant period, an IUL policy will either not lose money, earn a guaranteed minimum return rate, or only decrease by a limited amount.
The details vary by policy, and, in some cases, the applicable growth rate and cap depend on the specific index or indexes selected by the policyholder.
As a general rule, the greater the risk of loss the policyholder is willing to share, the greater the policy’s growth potential will be.
So, are cash value life insurance policies worth it?
Now that we’ve established how the various types of cash-value life insurance policies generally work, we need to return to the central question—are they a good deal?
Unsurprisingly, the answer is (once again) “it depends.” Specifically, it depends on how well-suited the chosen policy is to the individual policyholder’s situation and objectives.
Some policyholders are chiefly concerned with obtaining a death benefit guaranteed to provide a source of liquidity upon the insured’s death.
For instance, if you’re supporting a disabled family member financially, you might want to use life insurance to fund a special-needs trust.
When the policy is triggered, the death benefit funds the trust, which, in turn, helps provide for the disabled beneficiary without jeopardizing benefits eligibility.
Or, you might want guaranteed life insurance proceeds to pay for funeral costs—or to ensure your estate has sufficient liquidity to cover administrative expenses and estate claims.
In any of these scenarios, when you’re sure you need a reliable death benefit that will never expire, a classic whole life policy is an ideal choice.
You know exactly what you’re getting upfront, and the level premium structure makes it easy to budget for the policy.
Even better, whole life policies can eventually reach “paid-up” status where the coverage stays in place, but no further premiums are owed.
And, if in the future you can no longer afford the premiums, reduced paid-up options in most whole life policies let you opt for a reduced death benefit in exchange for a waiver of any additional premium obligations.
Final Expense Insurance
If you need to obtain a new policy later in life, many insurers market “final expense insurance,” which are whole life policies designed for older applicants who might have a hard time qualifying for coverage otherwise.
Final expense policies typically have relaxed underwriting standards and provide coverage ranging from $5,000 to $50,000, or so, based on the product and your age.
While guaranteed permanent coverage is a key selling point, there are plenty of other policyholders who are focused more on the long-term wealth-building potential of permanent life insurance.
When used as a retirement-planning tool, permanent policies offer tax-deferred growth that increases the value of a policy’s compounding interest.
Policy growth that exceeds premium payments is taxable income—but not until the money is actually withdrawn above the basis from the policy (like with a retirement account). As a result, the growth itself continues to grow without any present reduction for income taxes.
You can also access your money through life insurance loans. This is a great way to access your cash value without having to worry about taxes.
If you’re more focused on a permanent policy’s wealth-building potential, dividend paying whole life, universal life—and particularly IUL and VUL—can be an attractive option.
WL, IUL, VUL
Dividend paying whole life insurance allows you to focus on growing your cash value.
IUL lets you benefit from the dynamism of equity markets with significantly less risk exposure.
If you’re willing to tolerate a little more risk, VUL allows for increased upside.
In either case, the policy also benefits from the tax-deferred treatment of life insurance, and the death benefit is always waiting in the background—just in case.
An occasionally overlooked advantage of permanent life insurance as a wealth-building tool is that cash value can often provide access to credit through policy loans without diminishing the policy’s own growth.
Existing cash value is treated as collateral for a loan from the insurance company, but the cash value itself continues to grow tax-deferred within the policy (and qualify for dividends for participating whole life policies).
Ergo, if a policy loan can be put toward an income-producing asset or other investment that, along with policy growth, outperforms the interest on the policy loan, a policyholder can use life insurance to expand wealth and generate passive income.
This basic approach is employed in the “Infinite Banking” wealth-building strategy—though Infinite Banking has a few more nuances.
Key Person and Buy Sell Agreements
Permanent life insurance can also be a good deal for businesses. “Key person” policies provide cash to help a business overcome the loss of a vital employee.
And whole life or UL policies are a reliable way to fund buy/sell agreements between business partners.
If a partner dies, the policy’s death benefit provides the business or other partners with funds to purchase the departed partner’s interest from family members or the estate.
Or, if an insured partner retires, the policy’s cash value can likewise contribute to a buyout.
Similarly, permanent insurance (especially UL) has become a popular means of funding long-term compensation and benefits for executives.
Some carriers are even offering riders to policyholder businesses that give the business the right to change the policy’s named insured in the future.
When you boil it down, the question as to whether life insurance is “worth it” comes down to where you are in life and what you’re expecting from your policy.
If you need coverage to protect your family and are not concerned about life insurance as a financial asset, a level-term life insurance policy with a 20 or 30-year term (depending on your needs), could be an excellent decision—especially if you’re purchasing the policy while you’re relatively young and healthy.
A 30-year level-term policy issued by a solid company with competitive rates lets you lock in relatively low premiums over an extended coverage period.
If your family will be relying on your income during that coverage period, the peace of mind and just-in-case protection are, without a doubt, well-worth the cost.
Applicant age and long-term goals can also make a big difference when evaluating permanent life insurance as a financial planning tool.
The performance of whole life and UL policies might not look all that impressive over a short time horizon.
But if you can commit to a policy for 20 or 30 years, the compounding, tax-deferred growth usually ends up producing very respectable results—with little or no risk of loss. And, of course, you’ll have the death benefit if you ever need it.
When assessing the value of life insurance, a lot can depend on picking the right policy from the right company. An experienced, independent life insurance professional can be a huge help in finding the right fit.
So what are you waiting for? Give us a call today and experience the IBUSA difference!