There are many life insurance benefits worth talking about. However, our primary focus at I&E is on permanent life insurance. So, the majority of the article on the advantages and disadvantages of life insurance will be focused there. But before we begin, a brief introduction into the different types of life insurance policies available is in order.
Types of Life Insurance Policies
There are two primary types of coverage, with many different nuanced products available within the greater context of either term or permanent insurance.
Advantages and Disadvantages of Term Life Insurance
Term life is cheap, at least at first. A 30 year old man can get a $250,000 10 year term policy for under $10.
Term life is easy, it is basically pure death insurance. If you die, the policy pays out a lump sum death benefit to your beneficiary.
However, the disadvantages of term insurance should also be considered. Disadvantages such as:
A term life policy is temporary. Once the term policy ends, the coverage increases annually or the death benefit drops. Eventually, you will be priced out of the term policy, which is why 99% of term insurance expires and why we recommend convertible term life insurance if you must choose term.
Term insurance is a poor long term retirement plan. Often financial pundits, such as Dave Ramsey or Suze Orman, will say you should buy term and invest the difference. Unfortunately, no one follows through on this advice.
Further, life insurance is not an investment in the same way a mutual fund is. Comparing life insurance to an investment is comparing apples to zucchini. It is not the same thing.
So, now you have a general take on how we look at term. Often, people will pit term life vs whole life. However, in our experience it is not term vs whole, but whole life AND term life, blended together in a holistic strategic plan of wealth building and legacy creation.
Interested in learning more about our unique view of permanent cash value life insurance? Please read on.
Advantages and Disadvantages of Cash Value Life Insurance
We previously touted the many benefits of whole life insurance. For more on this topic, please visit whole life insurance pros and cons.
But returning to our topic at hand, let’s start out by touting the many benefits of life insurance, starting with the most obvious.
The cash value policy pays out a lump sum cash benefit upon the death of the insured for the benefit of the life insurance beneficiary. As the owner of the policy, you can also choose to pay the death benefit in installment payments to spread it out over a number of years. Other options are also available, such as interest only payments.
The bottom line is, your loved ones and estate get a quick influx of cash that can be used to settle debts, pay off creditors, provide for final expenses and burial costs, provide income replacement, pay estate tax, pay off a mortgage, etc.
Cash Value Growth and Accumulation
The longer you have your properly designed cash value life insurance policy, the more efficient it becomes. It is not unlikely that you can get an internal rate of return of 5% or more in your whole life insurance policy after the first few initial years.
And with features such as paid-up additions, you can greatly enhance your cash value accumulation, which also increases your whole life insurance death benefit.
Tax Favored Status
Cash value life insurance enjoys a tax favored status under the Internal Revenue Code, such as IRC section 7702 and 101.
As with all permanent cash value policies, whole life insurance cash value grows tax deferred. As long as you don’t surrender the policy or let it lapse, you can access the cash value via policy loans without incurring a taxable event.
You see, you can borrow from the cash value in your policy income tax free. And as the policy ages, many life insurance loans are considered wash loans, where the interest charged on the loan is the same as the interest earned on your policy’s cash value.
Also, cash value withdrawals are income tax free up to your basis in the policy. As long as you don’t touch the cash value gains, you will not have to pay taxes on a withdrawal.
Typically, death benefit from life insurance is not taxable. There are certain instances where this is not the case, but the typical life insurance policy arrangement will have the death benefit paid to the beneficiary tax free.
A properly funded and maintained irrevocable life insurance trust allow death benefit to remain separate from high value estates to avoid the estate tax. For high net worth estates, this benefit can literally save large estates millions of dollars.
Not happy with the performance of your policy or life insurance company? A 1035 exchange for life insurance or annuity typically allow you to exchange one policy for another with no tax consequences.
Depending on the type of permanent life insurance, you can change your premium payment and death benefit.
With whole life insurance dividends, you can use the dividend payment to pay premiums, cash out, pay off an existing policy loan, leave money with the carrier to gain interest or purchase paid-up additions.
Premium off-sets allow you to design your limited pay whole life policy to be self-sustaining after the first 7-10 years. The annual dividend may be enough to cover your annual premium, allowing you to continue to grow your policy’s death benefit and cash value, without having to make a premium payment ever again.
But you also have the flexibility of making the annual premium, allowing your dividend to purchase more paid-up life insurance, further enhancing your policy’s compound growth potentialities.
Life insurance living benefits are numerous as well. Depending on how you structure your policy, including different life insurance riders, will determine the living benefits you can access.
One living benefit of life insurance is the terminal illness rider, also known as the accelerated death benefit. If you are diagnosed with a qualifying terminal illness, you can access a portion of your death benefit.
A waiver of premium rider kicks in when you are permanently disabled. If you qualify, your premium is waived. Some companies also waive your paid-up additions premium, allowing your policy to continue to grow. And certain life insurance companies will allow you to convert your term policy to a permanent policy, and waive the permanent life insurance premium.
Another notable living benefit is the chronic illness rider. If you are diagnosed with a qualifying chronic illness, you can access a portion of your death benefit.
Finally, long-term care riders are optional provisions you can add to your policy that allow you to access funds to pay for long-term care services.
So, with those amazing advantages of life insurance, what are some of the disadvantages?
Disadvantages of Cash Value Life Insurance
We touched on many life insurance benefits above. But what are some negatives of life insurance that you may or may not have heard of?
You Have to Qualify
Traditionally, you were required to take a life insurance medical exam, which included a blood test and urine sample. If you did not pass the life insurance underwriting criteria, you could either be postponed or declined. And approvals can be slow with traditional fully underwritten policies, sometimes taking 6-8 weeks, or longer, for approvals.
Thankfully, the marketplace is changing, and many companies are going the route of no exam life insurance using automated accelerated underwriting. If you qualify for accelerated underwriting, you can often bypass the medical exam and be approved in as little as 24 hours, although most people can expect 7-10 business days for approval.
Cash value life insurance has a certain opportunity cost element to it because you are taking a large amount of your money and putting it into life insurance premiums. And whole life insurance rates are not as cheap as term life, so you can expect to pay 8-10 times more for a basic policy.
However, for a properly designed cash value accumulation machine, paying high premiums is just what the doctor ordered. There is nothing quite like cash value life insurance for building a retirement nest egg. And when you begin practicing infinite banking with your policy, you truly see how the velocity of money really works.
So, when it comes down to it, opportunity cost is not really a disadvantage for those who understand the benefits of life insurance.
In addition, we often recommend that you use passive income from another investment, such as real estate, to help fund your cash value life insurance. As your cash value grows, you can borrow against it via a loan and purchase another cash flow investment. When you do this, you are not having to choose life insurance assets or other investment opportunities, but rather, life insurance AND other investment opportunities.
Don’t Need It
We do not agree with this life insurance disadvantage, but it is often used by those in the investment world to cast a shadow on cash value policies.
It goes something like this: if you invest right, pay off your debts, etc., you will have no need of life insurance and you can self-insure instead. But the problem with this line of thought is many.
First, life insurance is leverage. You pay a relatively small premium for a large death benefit. From day one of your policy, your potential return is astronomical. Granted, overtime that return diminishes, but why self-insure when you can use other people’s money, i.e. the insurance company’s money?
Second, most Americans have very little to show for all their hard work. Many people have very little emergency money available. Life insurance provides the benefit of easy access to your policy’s cash value, providing you with maximum control.
Compare that to a 401k plan, that is simply a life deferment plan. It acts like a prison, keeping your money away from your control until some magical day somewhere out there, when you can finally access your own money, after paying your taxes on that money.
Or maybe you have money in the bank. But why are you settling for a fraction of the money the bank is producing from your deposit? You can use your life insurance as a personal bank and make many times the return that you are getting in your bank.
Life insurance is too confusing. That is a popular saying among those who don’t own it. However, for those who do own it, who take the time to look into the details and have decided to take their finances into their own hands, life insurance can be pretty straightforward.
The key here is to find the right life insurance agency and agent you can trust. Which brings us to our next point.
Lack of Trust
Part of the blame should be given to rotten egg life insurance agents who put clients into garbage policies in order to make high premiums. It is no different than attorneys or doctors who chase the almighty dollar at the expense of what is in the best interest of the client.
In addition, part of the blame for the lack of trust in the life insurance world is due to Wall Street. Simply put, most of those who make money from investing other people’s money don’t want to see that money go into cash value life insurance. They would rather it go into their coffers. So, they undermine life insurance and act like it has no value outside of term life, which can be dropped as soon as you “arrive”, whatever that means.
There are many life insurance advantages and disadvantages, even beyond the scope of this article. Our goal was to open your eyes to a few that you may have not considered.
The bottom line is that each person has a unique story, with his or her specific needs, goals and objectives. Therefore, the best life insurance may be different for you than it is for your friend or family member.
Our recommendation is you take some time to read through some of the various links in this article and throughout our website. Write down your questions and then give us a call for a free strategy session. You have nothing to lose and everything to gain.