HDMG - Life Insurance and Annuities as Investments Lesson
Life Insurance and Annuities as Investments
Life insurance may be the only insurance you never hope to collect on. By design, it is meant to provide funds to your beneficiary
, not you. That being said, it follows that there will be times in your life when you really don't need life insurance:
- If there is no one who depends on your income.
- If you have enough assets to pay for your final expenses.
- If your estate is small enough (under $5million) not to need additional tax deferral.
Term Life Insurance
Term life insurance means that life insurance will be valid for a specific length of time (usually 20 or 30 years) with the premium remaining the same for the entire time. Term insurance can be level term, which means the payout remains constant for the entire time the policy is in force. For instance, at 25 years old you buy a $100,000 30-year level term policy. If you die at any time over the next 30 years, your beneficiary would collect $100,000.
Term life insurance can also be decreasing term insurance. Like all term life, the premium is the same over the life of the policy, but with decreasing term life, the payout decreases each year. This type of term policy is popular for those who want to make sure their house is paid for if something happens to them because it is cheaper than level term. In addition, as the mortgage is paid and the balance on the house goes down, less money is needed to pay the house off.
Permanent Life Insurance
Permanent life insurance lasts until you die, as long as the premiums are paid, rather than for just a specific amount of years. In addition, permanent life insurance gains cash value as you hold the policy. You can borrow against this policy without being taxed on the earnings. Some people see this as sort of a "forced" savings. The catch is that permanent life insurance can be significantly more expensive than term life insurance.
Life insurance policies that earn cash value come in three types:
Term life insurance is an inexpensive and easy way to protect those who depend on you in the event of your death. However, all you get is insurance. Unless the policy has to pay out during the term due to your death, the premiums become sunk costs. Permanent life insurance, on the other hand, builds up a cash value that can be borrowed against and used during the life of the covered individual. With permanent life insurance, though, the cost can be very high. In fact, many advisors suggest that you buy term life insurance and invest the difference in cost. There is a place for permanent, whole life policies for individuals who have enough net worth that the policy can shelter some of their estate from taxes.
Who Needs Life Insurance?
In general, if no one depends on you for their livelihood, you don't need life insurance. So who does need it? View the list below. Be sure to click on each category for an explanation.
Annuities
An annuity is an insurance product that pays out income. It consists of a contract between you and the insurance company. You make either a lump sum payment or smaller payments over time, in return the insurance company pays you a regular payment over time.
Annuities can be immediate or deferred. An immediate annuity begins payments immediately and necessitates a lump sum investment. A deferred annuity begins payment at some future date. Money invested in either type of annuity can be invested in one of three ways.
- Fixed Annuity - This annuity pays out a fixed rate of return on your money. Because the rate of return is guaranteed, the income stream is predictable and not at the mercy of the ups and downs of the market.
- Variable Annuity - This annuity pays out a variable rate of return on your money. While a minimum rate is usually guaranteed, the amount can be higher depending on the performance of the investments you choose.
- Indexed Annuity - This annuity pays out a rate of return based on an economic index such as the Standard and Poor's 500 index. Indexed annuities are considered to be a cross between a fixed and a variable annuity. While the annuity has a minimum guaranteed rate of return, it can provide a higher return if the market does well.
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Pros and Cons of Annuities |
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|---|---|
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Pros |
Cons |
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Security and peace of mind of having a guaranteed monthly income
Don't have to pay a financial advisor to manage your money
Postpone paying taxes until you begin to receive income |
Higher returns through other investments
High commissions to annuity sales agents
Early withdrawal is expensive
Income depends on strength of the insurance company |
Self-Assessment
Try this self-assessment to check your knowledge. Read the questions and answer them on a scrap piece of paper or in your head. Hover your mouse over each of the questions to check your answers.
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