Should You Buy Life Insurance as an Investment?
August 21, 2014In response to this article we published on Forbes, we received this question on our Facebook page:
I recently read your article “Should You Use Life Insurance as an Investment?” on Forbes. I wanted to know how this article would apply to me. I just graduated and started my first job that pays pretty well. I don’t have any dependents so I didn’t think about life insurance until I meet with a financial advisor. He said starting insurance young is a better investment where I could keep safe dollars and be more risky in other parts. Would I be better off buying insurance now and benefiting from compound interest or use that money in other investments? Thanks!
Keep in mind that the purpose of life insurance is to provide for your dependents in case something were to happen to you. If you don’t have dependents, you probably don’t need life insurance. So why did this advisor recommend it? Probably because the type of insurance policies that can be used an investment (called cash value life insurance) also pay high commissions. Here are some other options that may be better off for someone just starting out:
1) Build an emergency fund. You’ll want to have enough money in cash to cover at least 3-6 months’ worth of expenses if you’re in between jobs. Much of your initial payments for life insurance tend to go towards paying the agent’s commission so it will take longer that way. Instead, stick to a bank account like these high-interest reward checking accounts or contribute to a Roth IRA since you can withdraw the contributions anytime without tax or penalty while the earnings grow to be tax-free after 5 years and age 59 ½. If you choose the Roth IRA route, just be sure to keep the money somewhere safe like a money market fund until you’ve accumulate enough emergency savings somewhere else. At that point, you can invest the Roth IRA more aggressively for retirement. Some good places to open a Roth IRA are discount brokerages and no-load mutual fund companies like Charles Schwab, Fidelity, Scottrade, TD Ameritrade, and Vanguard.
2) Get the match in your employer’s plan. If your employer gives you a dollar-for-dollar or $.50 match, that’s like earning a 100% or 50% guaranteed return on that money. No life insurance cash policy can match that, no pun intended.
3) Pay off any high interest debt. What’s high interest? Anything over the 5-7% that you can probably earn by investing the money instead. If you’re paying 20% interest on a credit card, you’d have to earn 20% in your life insurance policy or anywhere else after taxes just to break even.
4) Save for a home. Owning a home can save you a lot of money over renting in the long run and having a paid off home can be a huge asset in retirement. However, you’ll need savings for the down payment and closing costs. Once again, it will take longer to accumulate that in a cash value policy because of the fees.
5) Max out your retirement accounts. The main advantage of cash value life insurance is the tax benefits but you can get similar tax benefits from your employer’s retirement plan, IRAs, and HSAs without the fees that life insurance companies charge so make sure you’re maxing out all those accounts first. For safe money, you can choose low risk investments in these accounts and your employer’s plan may even have a stable value fund that tends to pay more interest than other low risk options.
Only once you’ve exhausted all the above options and actually need life insurance, should you consider a cash value life insurance policy. Even then, you’ll want to have it evaluated by a financial planner whose has no financial stake in your decision. (That includes both an agent trying to sell you a policy and a financial advisor trying to sell you another investment or who is compensated by how much of your assets they manage.) Instead, look for a planner who charges an annual retainer or hourly fee. Even better, see if your employer offers free access to an unbiased financial planner as part of a financial wellness program.
Have a financial question of your own? Feel free to submit it in the comments section below or on our Facebook page. I or one of our other planners can then answer it here or on our blog at Forbes.