This is probably the biggest question of all times. We’ve been sold on an idea for decades coming from the sole beneficiary of this financial plan… The life insurance company itself! Many think that because you own a whole life policy, you can put money into your life insurance policy and that the money grows without paying income taxes, that it covers all the benefits. Wrong! For most people, having a life insurance protection is the single most important financial transaction they will make. Mainly, it covers all the financial responsibilities you still have but are no longer on earth to make sure it is taken care of. That said, it is imperative to have your own financial situation evaluated by a professional. But keep in mind that you are the decision maker, so place yourself in a position to have all you need in hand to be comfortable making such a decision.
Having said that, I will go back to my initial thought about life insurance and point out that its main goal is to protect your family in case of a breadwinner dying too soon, leaving a family without the proper amount of savings to continue life easily. So, there is a life insurance need to respect. You can not consider being protected with a capital lesser than what you actually need. This is particularly a pretty big issue knowing that regarding on which life insurance product you will own, the premium associated to it varies a lot!
When this first step is accomplished, you are faced with the fatal decision of term or whole life? Taking into account that whole life premium cost is about 2 to 10 times (ohh yeah, I’ve seen 10!) higher than term life insurance, you can easily make the choice to pay a lower premium for your protection. Because it is not rare to see life insurance needs of 400k or 600k$, you don’t want to put all your budget for life insurance and if your need is 550k, you NEED to be an owner of a 550k life insurance policy. You don’t want to do the fatal mistake of lowering your coverage because the wrong kind of insurance costs to much a month!
Now… this is only the first step towards a financial freedom. The next part is putting money aside for savings AND investing. Many people say that it is hard for people to save money, so that’s why they should buy whole life insurance because everything is bundled into the same product and premium each month. Put it this way, if we take a person willing to put aside 500$, 1250$ or 2555$ per month, this person will maintain the same strategy regardless of which product he chooses.
2 things: flexibility and effectiveness
The first point that makes sense when looking at investing money is that you want to keep the control over that money over time. You don’t want it locked in or tied to any other product. That said, when using term life insurance, you pay the amount possible for your coverage and it leaves you with a bigger sum to invest. Now, you can use many tools today to make your money grow over time and for most people, those tools should include mutual funds suitable for you. We won’t discuss them here, but knowing the basis of mutual funds, you should expect a return from 4% to 8% per year on an average (with positive peaks and negatives slumps along the way). Coupled with that, you should be able to use a tax deferred investment vehicle that permits reporting or avoiding any tax payments that would normally be due on your capital gains or dividends. So you are left with the cheapest premium on earth for life insurance and the greater return tax free (or tax deferred). If anything happens along the way, you can still access your money freely without having to cancel anything (either your life insurance policy or your investment as a whole)
On the other hand, having everything wrapped up in a life insurance policy limits your possibilities. First, you pay much much more for the life insurance part. Also, you cannot choose the type of investment you want to invest with. Even thought the cash value is guaranteed in this type of insurance, you limit your potential returns to the guaranteed amount, not a penny more. And it is that guarantee that costs a lot. Do you think a life insurance company will offer guaranteed savings without first charging a premium for that? They are smart. They are the ones taking all the risks, so in exchange, you pay a higher premium and leave all the potential returns on the table to stay with a guaranteed amount. Another point is that for a period from 7 to 10 years, you will have access to a little or no cash value at all. Meaning that even thought you have paid to accumulate money, you won’t be able to withdraw it for the first 7-10 years. And at the first moment that you take off some money, even 1$, your guaranteed cash value are no longer guaranteed!
As a rule of thumb, if a client bought a whole life insurance policy at 35 years old, the amount accumulated in his policy will be equivalent to about 50% of his coverage at age 65. So a 300k insurance policy will offer a 150k cash value to him at 65. Not much for a retirement isn’t it? The best of all… you will have to pay taxes on the gains you have made over the years! Great isn’t it? (no tax ever on the proceeds if the policy owner dies, but taxes if any amount is withdrawn) And we still have to keep in mind that if you want to take your money out of your policy, you will either have to pay it back with interest OR surrender you policy to the company! So you have invested in a vehicle that was supposed to protect your family as long as you lived but now it has to be cancelled!
I’ll leave you with this: regardless of if you make 50,000$ or 500,000$ per year, your life insurance needs should always be covered by a term life policy! Always! Being properly protected, now you can use tax free savings account for investment purposes.