My answer to this: it depends.
If someone relies on you economically, then you need insurance. But do you select a term or a permanent policy?
When you hear advisors and agents suggesting that you “invest” in life insurance, they are referring to the cash-value component available in permanent, also known as whole or universal life insurance. This concept does not apply to term life insurance, which can be thought of more like a rental versus something you own.
Pros of permanent life insurance:
- Tax-deferred growth (although you can also take advantage of this by maximizing your retirement accounts).
- Estate planning tool (pay for estate taxes, leave cash to beneficiaries).
- Borrowing capacity.
- Lifelong coverage.
Cons of permanent life insurance:
- Expensive: High premiums, management expenses, and agent commissions.
- For more about commissions, check out my post about how a Fee-Only Advisor is compensated.
- Surrender period (it should not be considered a short-term investment).
- No tax deduction for payment of premiums (unlike some retirement account).
- Increased number of riders and acronyms equates to a lot of complexities.
My advice? I would consider permanent life insurance if:
- You have maxed out all retirement accounts (i.e., 401(k), backdoor Roth, HSA).
- Speaking of this…have you asked your employer if your company-sponsored 401(k) gives you access to a Mega Backdoor Roth?
- You have a healthy, diversified taxable account (including an emergency savings fund).
- You are looking for guaranteed but moderate growth (think “bond-like” returns).
I would not consider it if you are:
- In a low tax bracket.
- Using it to purely save for retirement.
- You could consider term insurance and invest the difference in premium in the market. The thing is you have to do the latter or have someone hold you accountable. Do not spend it!
- Already have a permanent policy and need to get out of it?
- Surrender the policy – I would avoid doing this during the surrender period. Also, keep in mind there will be tax consequences above your basis.
- Keep the policy – is it a reasonable diversifier? Are the payments flexible (i.e., it is a universal life policy)? Do you have any life events on the horizon where borrowing against the policy might make sense?
- Exchange the policy into a different insurance product that makes more sense for you while reducing tax consequences.
While I don’t write insurance given that I’m a fee-only advisor, I most definitely analyze the protection need and talk through different scenarios as I believe insurance analysis is part of a comprehensive financial plan. Verify that the amount of insurance makes sense to you: are you calculating your economic need, or just taking whatever coverage is sold to you?
Have more questions about whether you should invest in life insurance? Schedule time with me when you’re ready to chat.