Welcome to your “2-Minute Money Manager,” a short video feature answering money questions submitted by readers and viewers.
Today’s question is about investing; specifically, whether a life insurance investment should be a part of your portfolio.
Watch the following video and you’ll pick up some valuable info about the advantages of life insurance and alternatives to life insurance. Or, if you prefer, scroll down to read the full transcript and find out what I said.
You also can learn how to send in a question of your own below.
For more information, check out “7 Questions You Need to Ask Before You Buy Life Insurance” and “8 Ways to Save on Life Insurance.” You can also go to the search at the top of this page, put in the word “insurance” and find plenty of information on just about everything relating to this topic.
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Got a question of your own to ask? Scroll down past the transcript.
Don’t want to watch? Here’s what I said in the video
Hello, and welcome to the “2-Minute Money Manager.” I’m your host, Stacy Johnson, and this two-minute answer is brought to you by MoneyTalksNews.com, serving up the best in personal finance news and advice since 1991.
Today’s question comes to us from Fernando:
“I am 42 years old and single. I finally paid most of my debt and I’m ready to invest. I have no clue where to start or what’s best for me. I can invest $3,000 a month. I’m thinking $1,000 in life insurance, $1,500 in stocks, and $500 in a savings account. Is this a good idea?”
Well, Fernando, I don’t know what you already have in emergency savings. But if you don’t have much, I want you to bulk that up first. The other two ideas you’re considering are relatively illiquid, meaning more difficult to convert to cash. So, you want to have a fat savings account before starting work on your financial goals. You also want to make sure you’re putting as much as possible in whatever retirement plans you’re eligible for.
We’ll assume for the sake of this question that you’re fully funding your retirement plan and have adequate emergency savings, and that this $3,000 monthly is extra money available to invest. Is life insurance a good investment for retirement? Will it make money? In other words, is life insurance worth it?
Fernando says he wants to put $1,500 in stocks, which I think is great. But $1,000 a month in life insurance? Let’s talk about that. Here are three things to consider when approaching a life insurance investment:
Thing No. 1: The types of life insurance
There are two types of life insurance. There’s term, which insures your life for a certain term — like five, 10 or 20 years. Then, there’s permanent life insurance, which you theoretically keep until you ultimately die.
Here’s how people typically use insurance: They buy term insurance when they’re 30ish and have young kids. Should they die prematurely, the terms of the death benefit will take care of their family. They maintain the coverage until age 60 or so, when the kids are grown, on their own and the need for insurance fades. As they reach the end of the term and insurance starts getting expensive, they don’t need it anymore, so they drop it.
Note that with term insurance, the only way to get cash from the insurance company is to die. Like your car, home and health insurance, it’s protection. It’s not an investment.
As the name suggests, permanent insurance is a policy you intend to keep permanently. Part of your monthly premiums pay for the death benefit, and another part goes into an internal savings account. With a permanent policy, you don’t have to die to reap some benefits because you’re building cash value. When people ask me “is life insurance considered an asset,” the answer is usually no — but the cash value of this type of insurance could be considered an investment.
Thing No. 2: Permanent is more expensive
You’re probably thinking, “Since permanent insurance comes with an investment account, and it’s bound to pay off sooner or later, it’s a better deal, right?” Well, not necessarily, because it costs a lot more.
Here’s an example I recently read: A 30-year-old, healthy, nonsmoking woman can get a $1 million, 20-year term life insurance policy for $500 a year. But that same woman buying the same $1 million death benefit in a permanent policy might pay $10,000 a year. It’s building some cash value, but is this the best possible use of your extra cash?
In other words, it’s an investment, but is it a great investment?
There’s a common expression among financial advisers: “Buy term and invest the difference.” It means that instead of putting $10,000 annually into a cash value, permanent policy, you’re better off paying $500 for a term policy that will protect your loved ones, then investing the $9,500 difference into something else, like maybe an income-producing stock mutual fund.
Why? Because permanent life insurance policies have a lot of fees and administrative expenses that often make them less efficient as an investment than other choices. So if you’re wondering “is whole life insurance a good investment?” the answer is: not especially. If you can make a lot more with the same money elsewhere, you see why whole life insurance is a bad investment.
Thing No. 3: Permanent isn’t always bad
There are situations where whole life insurance as an investment makes sense. For example, if your heirs could be facing an estate tax problem, permanent insurance can help pay the taxes when you die. However, you’ve got to be rich for that strategy to make sense. In 2018, with proper planning, a couple can shelter $20 million from estate taxes.
A life insurance investment does have other benefits. For example, you don’t pay taxes on the interest or other earnings until you take them out. Also, you have the ability to borrow against a cash value policy. Still, most experts will say these benefits aren’t enough to offset the higher expenses that often accompany these policies.
When approaching insurance or any other type of investment that’s new to you, I’d urge you to talk to a general financial planner, not the salesperson from the insurance company. Looking at what Fernando suggests, investing $1,500 in stocks and $1,000 in insurance, leads me to believe he got that advice from a commissioned insurance salesperson, not a fee-based, holistic financial planner. One will give you a clear answer to “why should life insurance not be used as an investment?”, and one won’t.
I hope I answered your question, Fernando.
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I founded Money Talks News in 1991. I’m a CPA, and have also earned licenses in stocks, commodities, options principal, mutual funds, life insurance, securities supervisor and real estate.
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