How To Use Life Insurance as an Investment

Most of us think about life insurance in terms of its death benefit — aka the payout for your loved ones if you die. 

But did you know that most individual life insurance policies also accumulate a separate cash value that can be accessed while you’re alive? 

These permanent policies combine elements of insurance and investing, making them seem like the best of both worlds. But permanent life insurance is pricey and has fine print that turns off many investors. 

. . .

How Does Permanent Life Insurance Work as an Investment?

When you buy a life insurance policy, you agree to make regular payments, called “premiums,” to an insurance company. 

That company then pays your beneficiaries — the loved ones you designate in your contract — a specific amount of money (a “death benefit”) if you pass away due to a covered cause while your policy is active.

There are two types of life insurance:

• Term life insurance pays out its death benefit if you die during a limited time frame. 
• Permanent life insurance pays out its death benefit no matter when you buy the proverbial farm. 

One of the other big differences between term and permanent life insurance is that permanent policies accrue cash value. 

This cash value can be used in a few different ways.

Use the cash value to pay your premiums during hardship

Cash value can be used to pay your policy’s premiums if there are times when your income dips. 

This can help prevent the policy from lapsing and ensure that your beneficiaries will retain access to the death benefit.

Use the cash value to take out a no-credit-check loan

A permanent policy’s cash value can also secure a loan from your insurer. 

Unlike most loans, a policy loan won’t require a credit check, which can help you access funds if you have a poor credit score and need to cover a major expense, like a home renovation. 

Because cash-value loans’ interest rates typically range from 5% to 8%, they can also be used to consolidate high-interest debt. 

Use the cash value to pay for retirement expenses

You can withdraw from your permanent policy to supplement your income in retirement — but this will reduce the policy’s cash value and death benefit. 

Withdrawals up to the total amount of premiums you’ve paid into the policy are untaxed.

Types of Life Insurance That Can Be Used as an Investment

Permanent life insurance can be divided into three main subtypes: whole, universal, and variable.

Whole life insurance

The terms “whole” and “permanent” life insurance are often used interchangeably, probably because whole life insurance is the most common subtype of permanent insurance. 

Whole life policies are popular because their cash value grows based on a guaranteed interest rate.

Some insurers’ whole life policies also earn dividends, which can be used to increase the policy’s death benefit, grow its cash value, or pay its premiums. 

Universal life insurance

Universal policies’ premiums can be adjusted up or down based on your preference, making them more flexible than whole life policies. 

This may be attractive if you’re a small business owner with unpredictable income.

Variable life insurance

Variable life insurance invests your cash value into securities, like stocks, bonds, and mutual funds. Your policy’s cash value fluctuates with the performance of the securities you choose.

Their premiums are adjustable, and you can choose how to invest the money you pay into the policy.

READ MORE: How To Start Investing

Pros and Cons of Using Life Insurance as an Investment

Permanent life insurance may seem like an ideal way to provide for your dependents after you die, while also setting aside a nest egg to use while you’re alive. 

But its drawbacks make it only appealing to a niche group of investors.

Pros

• Tax advantages: Unlike a regular savings account, a permanent policy’s cash value grows on a tax-deferred basis.
• Consistency: Premiums stay the same for a permanent policy’s lifetime. They won’t shoot up when you get older or develop health problems.
• Flexibility: Cash value can be used for virtually any purpose. And unlike traditional 401(k)s and IRAs, you’re not required to take distributions from your policy once you reach a certain age, and you can withdraw your cash at any age without penalty. 
• Forced savings: If you're not the type who's naturally inclined to sock away money each month, the threat of a life insurance policy lapsing might be the motivational kick you need to consistently save. 

Cons

• Price: Permanent life insurance policies are expensive. Whole life policies can be anywhere from about six to 22 times the price of term life.
• Caveats: A permanent policy’s cash value is only accessible during your lifetime. The insurer pockets what remains of your cash value when you die, which is one of the many ways that life insurance companies make money.
• Time: It takes several years for a policy’s cash value to accrue. And if you choose to discontinue the policy within a few years of taking it out, you might have to pay a high surrender fee.

READ MORE: How Much Does Life Insurance Cost?

Is Permanent Life Insurance a Good Investment?

Permanent life insurance has many detractors. 

Several Erika Taught Me podcast guests — including Dave Ramsey, Ramit Sethi, and Rachel Cruze — have spoken out against permanent policies’ high premiums and low returns. 

Returns do seem dismal when you consider only the cash value. The cash value in a whole life policy quote I recently received from MassMutual had a guaranteed annual growth of about 0.43% over 40 years. 

That's well below the return on investment needed to beat inflation. 

But my quoted policy’s guaranteed annual growth improved to about 5.1% when considering both its cash value and death benefit. Potential dividends, which are expected but not guaranteed, further improve the policy’s growth prospects. 

These kinds of numbers make permanent life insurance policies worth considering in limited circumstances:

1. If you have a dependent who will be unable to provide for themselves after you’re gone, like a child with an intellectual disability, a permanent life insurance policy’s death benefit can help cover their needs. 
2. A permanent policy’s cash value can diversify your assets. If you’re a high-income investor and already max out the annual contribution limits for your other tax-advantaged retirement accounts, it’s worth considering.

If you need life insurance but the above scenarios don’t apply, shop for a few different term life insurance quotes on an insurance marketplace like Policygenius. A term life policy from a reputable insurer can keep your loved ones on their feet once you’re gone, and its premiums should be low enough to fit into your budget comfortably. 

The extra cash that would have been spent on a pricier permanent life insurance policy can instead go to investments with higher potential returns and fewer strings attached.

FAQs

Is life insurance considered an asset?

A life insurance policy’s death benefit typically isn’t considered an asset, so it won’t be used to pay off your remaining debts when you pass away. 

A permanent life insurance policy’s cash value, however, is considered an asset, because you can benefit from it while you’re alive. These types of policies are considered assets when you apply for a mortgage or go through a divorce.

Is life insurance taxable?

The IRS usually does not consider the proceeds of a life insurance policy’s death benefit to be taxable income. But a permanent life insurance policy’s cash value may be taxable if you withdraw more money from it than the total premium payments you’ve made.

How much is whole life insurance?

Policygenius reports that the average whole life insurance policy for a 30-year-old woman in good health with a $500,000 death benefit costs $414.50 per month. 

Whole life insurance premiums can vary widely depending on a policy’s death benefit amount as well as your age and medical profile.

TL;DR

Permanent life insurance includes a cash value that grows over time and that you can tap into while you’re still alive. The catch is that premiums are expensive and if you don’t use the cash value before you die, it goes back to the insurance company — not to your heirs.

But if you have dependents with special needs or are a high-income investor looking to diversify your assets, you may want to consider using life insurance as an investment.

For other ideas on how to best invest, check out these episodes of the Erika Taught Me podcast:

• How To Invest for Beginners (Step by Step)
• The 7 Baby Steps You Need to Get to Financial Freedom
• The Missing Piece in 99% of Financial Advice

. . .