The Truth About Buying Life Insurance as an Investment

What do a vacuum and life insurance as an investment have in common? They both suck. The difference being that vaccums suck in a good way. The other sucks in the worst ways.

Life insurance as an investment is a “strategy” insurance companies push at people who want to protect their families and build up a retirement. It’s marketed as what the “wealthy” do. But is life insurance really a good investment? Absolutely not.

Let’s take a look at how life insurance as an investment is sold—so you can avoid it.

The Purpose of Life Insurance

Before we dig into why using life insurance to build wealth is such a bad idea, it’ll help to be clear about what life insurance is supposed to do. The purpose of life insurance is to replace your income if anything should happen to you so your loved ones are provided for financially. That’s it. And don’t let any slick-talking “tax-free wealth strategist” on a social media video tell you different.

Term life insurance does this well. All it does is pay your family a specific amount if you die during the policy’s term. And most people can get a policy worth 10–12 times their annual income for a reasonable price.

Whole life or cash value insurance (which is what you have to buy if you want to use insurance as an investment) is much more expensive because it’s trying to be insurance and an investment (you’d think it was weird if your car insurance came with an investment account, wouldn’t you? Same goes for your life insurance). That’s too much for one financial product to do well.

And spoiler alert: Cash value life insurance gives you one of the lousiest returns on your money you can think of—including not getting any of it sometimes!

Let’s talk about how life insurance as an investment is supposed to work, and why it doesn’t.

How Investors Use Life Insurance as an Investment Strategy

“Experts” peddle permanent or whole life policies like indexed universal life or variable universal life as investment plans because they have an investment element to them. Along with the life insurance policy, there’s an investment account that’s supposed to build cash value. So, on the surface, they are really an investment strategy—just a pitiful one, but we’ll get to that in a minute.

Here’s how these whole life policies work: You pay a monthly premium like with any normal insurance, but part of your premium goes toward your life insurance coverage and the rest goes into a tax-deferred investment account that will grow in the background while you live out your life.

Once you’ve built up some cash value, you can withdraw or borrow some of it. But doing either will reduce the death benefit amount your family would receive if you die before you pay it back. Oh—and you might have to pay taxes on it too.

I mentioned a couple examples above, but there are a few different flavors of whole life insurance: We’ll start with basic whole life and then I’ll move on to the variations.

Whole Life or Permanent Life Insurance

With this one, your insurance company decides your investments. As you grow older, your premiums rise and the percentage of your premium going toward your cash value drops while more goes toward paying for your life insurance. Your cash value account grows at a rate fixed by the insurance company.

Universal Life Insurance

With universal life, your premiums are adjustable, which means you might be able to use money from your cash value account to offset rising premiums. Your cash value account grows at whatever rate your insurance company sets, and they can change it. Some insurers set a minimum rate of 2%.

Variable Universal Life Insurance

This is pretty much the same as universal except you get more options when it comes to how your cash value account is invested. And the value of those options can vary (variable, get it?) over time.

Indexed Universal Life Insurance

With this kind, your investment or cash value account is tied to an index fund. The percentage of your premiums going to insurance versus investment is the same as the others.

Why Life Insurance Is a Bad Investment

So all of that sounded all right, yeah? Hang on. I’m now going to rip back the curtain on this imposter of an investment strategy.

The whole deal where some of your premiums go toward life insurance and some toward investments can seem really good. After all, it feels like you’re getting a return on all those (wasted if you don’t die) life insurance premiums. Because that’s one of the big reasons people don’t want to get life insurance—they may never need it and then all those premiums are pointlessly gone. This isn’t really true—but that’s how it feels.

With the cash value element, you not only get some money back, but the insurance company has been “carefully stewarding” it for you, investing it in crappy investments and taking most of the profit in fees. Not cool. Not hot. It’s not even mid (Gen Z, you’re welcome). The insurance company usually picks out the investments and here’s the thing: Insurance companies aren’t good at investing—and they don’t have to be because these insurance products are designed to make them money, not you.  

But, you say, I’m still getting money back at the end of the day! Maybe. If you die before you reach the maturity age, the insurance company gets to keep any unused cash value. When is maturity age, you ask? Oh, just 120 years old! Yep, that’s right, most insurance companies define maturity age as a spry 120. Unless you’ve got the genetics of Methusaleh, good luck enjoying all that cash value you haven’t really built up.

Oh, and have I mentioned the fees? If your cash value manages to scrounge up some returns, the insurance company will be sure to take their share by charging many fees including: premium payments, surrender charges, and ongoing investment management and administrative fees. It’s like you’re Cinderella and the stepmother insurance company just keeps finding more chores for you to do so you’ll never get to the ball.

You also run the risk of your policy lapsing when you tie it to investments. Insurance companies keep a close watch on how much money you have in your cash account. If you don’t have enough money to cover policy fees, your policy could lapse, and your coverage would be cancelled.

What about the tax-deferred part? Well, tax-deferred earnings can be good, but in this case they’re just not enough to make it worth it. Plus, you can get other tax-advantaged earnings using better investment strategies—like a Roth IRA or Roth 401(k)—that put you in control of your investment selections and open the door to mutul fund investments that get much higher rates of return!

Another reason investing in life insurance is a bad choice: massive premiums. You’re not actually getting any of your premiums back through the cash value account. They’re just charging you more to have that option. If you took the difference between what you’d pay for a policy with investments tacked on and what you’d pay for a plain term life insurance policy and invested it in a good mutual fund, you’d have so much more in the end. And nobody would be shaving it down with fees and crazy rules like you don’t get anything if you die!

I used the Term vs. Whole Life calculator below to see how much more a 35-year-old guy would save by getting a term life policy instead of whole life. The savings add up to $2,365 a year!

Then, to get nerdy with it, I plugged that into Ramsey’s Investment Calculator. By investing that $197 a month from age 35 to age 67 in mutual funds that average an 11% return, you’d end up with over $693,000—just by investing the savings on your insurance premiums!

The Best Way to Invest and Get Life Insurance

So, you’re pretty convinced buying life insurance as an investment is about as smart as buying Beanie Babies as an investment. But you still want to build wealth and be secure in retirement, and you want to protect your family—so how do you do that? You’ve come to the right place.

Investing the Right Way

It might be obvious that get-rich-quick schemes aren’t a good bet—but neither are the “safe” options like gold or bonds. That’s because their rates of return don’t even keep up with inflation. That’s why I’m a big fan of good growth stock mutual funds. But first, let’s talk about when you should invest.

You might think you’re ready now, but not everyone is actually ready to start investing. First, make sure you’re out of debt and have a fully loaded emergency fund. Figure out where you are along the path to building wealth and if you’re ready to start investing by checking out the Baby Steps. Whether you’re just starting out or you’ve been working on your finances for a while, following a plan will help you build wealth the right way.

Once you are ready to invest, I recommend investing 15% of your household income in good growth mutual funds. Mutual funds with a track record of around 10–12% growth for 10 years or more are where it’s at. And like I mentioned before, you can invest in mutual funds through a Roth IRA or your 401(k) at work. No get-rich-quick schemes. No crazy Wall Street bets. No picking single stocks like random candies from the bulk bins at an international grocery store.

I went from negative net worth to millionaire within 10 years by following these principles. Investing can be intimidating though, I get it, so don’t feel like you have to do it alone. An experienced financial advisor can give you a big leg up when it comes to your money game.

Life Insurance the Right Way

Now what about life insurance? Some things aren’t simple—like trying to eat healthy. (Gluten-free, organic, non-GMO, glyphosate-free oat milk anyone?) But life insurance, thankfully, is extremely simple. Instead of a permanent life policy with a wasteful investment component, buy term life insurance.

Remember what life insurance is supposed to do? Replace your income—that’s it. And that’s what term life does. If you have a policy worth 10–12 times your annual income, your family will be protected in case the worst should happen. The good people at Zander Insurance can hook you up with a term life policy that offers the right amount of protection for the right price.

Not only have they served my family for over a decade now, but they’ve been serving fans like Ryan B. from the Baby Steps Facebook Community Group for over 20 years! When he switched to Zander, Ryan saved $19 a month.

“Seeing how Zander got me about 30 quotes in 30 seconds and I got to choose the best one, I’ll roll with Zander,” he said.