What Is an Investment Policy?
With life insurance, you basically have two options from which to choose: term life, also known as pure insurance coverage, and whole life, which combines an investment vehicle with elements of term life insurance. The main difference between the two is that whole life policies build cash value. Also known as permanent life insurance coverage, whole life insurance allows policyholders to enjoy tax-deferred investment growth. In this way, whole life is considered an investment policy, or a policy that accumulates value in excess of the face-value death benefit over time. We will explain more about life insurance investment policies and address if they're right for you in what follows.
Types of Investment Policies
Investment policies come in three forms: whole life, universal life, and variable life policies. Each of these policies is explained below.
- Whole life. Premiums remain constant over the life of the policy, and cash value accumulates on a tax-deferred basis. Whole life policies also sometimes provide dividends, but they are not guaranteed. This type of policy can be used to supplement retirement income.
- Universal life. Premium payments are applied toward the accumulation fund that earns interest. You can then borrow against or withdraw from the cash value or use it to pay you premiums.
- Variable life. Variable life is the most aggressive investment policy. This type of coverage allows you to invest the cash value of the policy in different funding options that then invest the money in things like stocks and bonds. In this scenario, you can decide how your money is invested, but you also bear the investment risk.
Is an Investment Policy Right for You?
The main appeal of a life insurance investment policy, especially as a retirement-planning tool, is its ability to offer tax-deferred growth. Tax-deferred growth means that income tax and capital gains tax are delayed on the accumulation account. Whether a life insurance investment policy is right for you primarily depends on if you would be better off purchasing a cheaper term policy and investing the difference on your own. Whole life policies typically come with high commissions and fees, which makes them many times more expensive than pure term life insurance. Here are some things to consider:
- Can you afford the premiums? After you determine how much coverage you need, look up the premiums for both term and whole life policies. If you cannot afford the whole life policy, go with term coverage. Don't ever reduce your death benefit in order to afford a whole life policy.
- What tax bracket are you in? Tax-deferred investment growth won't be that valuable to you unless you're in one of the highest income-tax brackets.
- Will you be able to get affordable coverage as you age? When you get older and your health begins to deteriorate, term life insurance could become prohibitively expensive or you could become uninsurable altogether.
- Are you willing to shop for no-commission insurance policies? Unless you purchase a no-commission policy, the commission fees associated with whole life will erode any financial benefits it has to offer.