Is Life Insurance a Good Investment?
Life insurance can seem like a straightforward deal: pay premiums, and your loved ones receive a tax-free sum after your death. This payout can help cover living expenses and other financial needs. But is life insurance always a worthwhile investment? Do you truly need it, and are there potentially better ways to manage your finances?
When Life Insurance Makes Sense
Generally, life insurance is valuable if your death would place a financial burden on others. Consider coverage in these situations:
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Covering Burial Costs: Funerals are expensive, and your loved ones might not have the immediate funds to cover these costs. Life insurance can provide the means to pay for final expenses like burial or cremation.
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Income Replacement: If someone, such as a child or spouse, depends on your income, life insurance can replace your earnings after you’re gone. This can help maintain their standard of living.
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Debt Coverage: While most debts don’t automatically transfer, co-signers, co-owners, and spouses in community property states might be responsible for outstanding balances. A life insurance policy can cover these debts, easing the burden on those left behind. It may also be wise to get life insurance on someone else, for example, if you rely on your spouse’s income, you can buy a policy on their life to cover living expenses if they die.
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Employer-Provided Coverage: If your employer offers free life insurance, accepting it is a smart move. It might not fulfill all your needs, but it’s a valuable perk.
When Life Insurance Might Not Be Necessary
If your death wouldn’t cause financial hardship for anyone, life insurance may not be the best use of your resources. Consider these scenarios:
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No Financial Dependents: If no one relies on you financially, you might gain more by building your own wealth rather than purchasing a life insurance policy, especially if the payout isn’t crucial for someone’s survival.
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Budget Constraints: Life insurance premiums must fit comfortably within your long-term budget. Permanent policies last a lifetime, and term policies can extend for decades. If you can’t commit to ongoing payments, the policy can lapse, leaving your beneficiaries with nothing.
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Focus on Wealth Building: Although certain permanent life insurance policies offer a cash value element, the primary role of life insurance is to provide a death benefit, not to serve as an investment vehicle. All policies will include charges. Talk with a fee-only financial advisor about other options that can best help you build wealth.
The Advantages of Life Insurance
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Death Benefit: If the policy is active upon your death, the beneficiaries receive a payout.
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Tax-Free Cash: Generally, life insurance payouts are not subject to income tax.
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Direct Inheritance: In most cases, the payout goes directly to the listed beneficiaries, bypassing the estate.
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Loan Access: You can often borrow against the cash value component of a life insurance policy.
Possible Drawbacks
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Risk of Cancellation: Missed payments can lead to policy cancellation, leaving your loved ones without a death benefit.
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Cost vs. Payout: Especially with age or health issues, the potential payout might not justify the expense.
Is the Cost Worth It?
The cost of life insurance varies based on age and health. Buying a policy when you’re younger and healthier helps you secure a lower rate. Here are average annual life insurance rates for applicants in excellent health buying $500,000 of coverage. (Data valid as of April 15, 2024).
Average Annual Rates for Women
Source: Covr Financial Technologies. Lowest three rates for each age averaged.
Average Annual Rates for Men
Source: Covr Financial Technologies. Lowest three rates for each age averaged.
Types of Life Insurance
There are two main options:
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Term Life Insurance: Provides coverage for a specific term, such as 10 or 20 years. This is the most affordable type and often sufficient for most people, letting you align the term with the years others will depend on you financially.
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Permanent Life Insurance: Offers lifetime coverage and includes a cash value component, which can be withdrawn or borrowed against. There are various permanent policies, including:
- Universal life insurance
- Indexed universal life
- Variable universal life
- Whole life insurance
