The roaring stock market would seem to make 2021 an ideal year to choose permanent life insurance — the policy type that combines a death benefit with an investment component. But, even now, be careful about opting for a permanent policy over term life insurance.
Permanent policies such as whole life insurance and universal life insurance provide a death benefit, just as a term policy does. They also add a component known as cash value, which accumulates separately and can be tapped beginning a few years into owning the policy.
The accumulating value of the policy is even tax-deferred, much like 401(k)s and other retirement options. And, as the name infers, the death benefit is permanent, at least as long as you pay the policy’s premiums. (Term policies, by contrast, expire after 10 to 30 years.)
Elaine Tumicki, corporate vice president and director of Insurance Product Research at LIMRA, says permanent life insurance can suit those who are interested in a death benefit that doesn't expire and will pay out whether you die at 50 or 90. These policies can be especially useful to those who want to create an estate and leave a legacy for children or grandchildren, she says.
Appealing as all that may sound, permanent life is anything but a slam dunk choice for many people, even in a year when the Dow has already set records on more than 20 days. Here's the information you need to understand what these policies do and don’t offer.
Permanent-life premiums can be pricey
An investment’s long-term payoff doesn’t help you pay its costs in the short term. And the premiums for the most common permanent life policies -- whole life ones, in which the cash value is guaranteed -- are higher than for term insurance. So much so, in fact, as to make these policies a non-starter with many or most people.
For example, Haven Life says the premium for a $500,000 term policy it issues on a healthy 35-year-old would be about $44 a month. The premium for the same coverage under a whole life policy from a major insurer, Haven Life says, would be about $561 -- more than 12 times as much. That gap in premiums is in line with other estimates, and by quotes from online insurance broker Top Whole Life, which quotes an almost identical premium of $516 a month for $500,000 in coverage on a healthy 35-year-old male from “one of the most solid companies” whose policies it sells.
Don’t assume you'll make as much as the market as a whole
Like most investment vehicles, permanent life policies span a range of risk and potential return, from “conservative to aggressive,” according to Scott Witt, founder of Witt Actuarial Services in New Berlin, Wisconsin. “How your policy performed in the past year is going to depend entirely on the kind of policy you have.”
Some policy types, such as traditional whole life insurance, are on the conservative end of the spectrum, and favor safer and more stable investments such as bonds or guaranteed funds. People who invested in these policies are largely unaffected by stock market fluctuations, explains Witt.
On the other hand, variable universal life policies allow you to invest in securities and other more volatile choices. But some of the most popular of those, known as an indexed universal life policy, come with financial guardrails that limit how much they can drop in value -- but also how much they may rise.
While these products, as their name implies, are indexed to such indicators as the S&P 500 or the Nasdaq 100, they typically have caps on their gains and losses. Those caps currently run to around 10%, says Witt, which is well below the market gains on many indexes in the past year.
“Generally speaking, indexed policies are closer to conservative policies than they are to aggressive policies,” Witt adds. As such, policyholders may benefit less than they expect from a strong stock market.
Insurance and investment aren’t necessarily a natural fit
“For some people, [permanent life insurance] can be a great investment. But that's a relatively small subset of people,” says Witt. “Above all, life insurance is most compelling typically as an investment for high-net-worth individuals who are in a high tax bracket and are dealing with taxable accounts,” he adds.
Such investors may well have maxed out their contributions to other tax-deferred products such as traditional IRAs, and have money sitting in a taxable account that they’d like to have sheltered. Those investors aside, Witt says. “the vast majority would be far better off buying term insurance for getting their death benefit needs fulfilled.”
Witt suggests other ways of growing your money, like purchasing term life insurance and investing what you save in premiums directly in stocks or mutual funds. “If you're a buy-and-hold equity investor under the current tax regime — you already enjoy most of the tax benefits that are afforded cash-value life insurance,” says Witt.