Can You Use Life Insurance as a Retirement Investment?

At some point in your life you will almost certainly be pitched the idea of life insurance as an investment.

The pitch will sound good. It will sound like you’re getting a guaranteed return, with little to no downside risk, and that the money will be available for just about anything you want at any time.

Well, I’m here to tell you that things are not always what they seem, and that with a few rare exceptions you should avoid life insurance as an investment. Here’s why.

First, a Quick Primer on Life Insurance

Before getting into all the reasons why life insurance is not a good investment, let’s step back and look quickly at the two main types of life insurance:

Term life insurance: Term life insurance is a set amount of coverage that lasts for a set amount of time, often 10 to 30 years. It’s inexpensive and there is no investment component to it. It’s pure financial protection against early death.
Permanent life insurance: Permanent life insurance comes in many different shapes and sizes, but essentially it provides coverage that lasts for your entire life AND it has a savings component that can be used like an investment account. You’ll also hear it called whole life, universal life, variable life, and even equity-indexed life. Those are all different types of permanent life insurance.

There’s an entire discussion to be had about term life insurance vs. permanent life insurance from an insurance perspective, but that’s the subject of another post. (Hint: Most people only ever need term life insurance.)

Here we’ll focus on the savings component of permanent life insurance that’s often pitched as a fantastic investment opportunity.

Here are seven reasons why life insurance is almost never a good investment.

1. The Guaranteed Return Is Not What It Seems

One of the big stated benefits of whole life insurance is that you get a guaranteed minimum return, which is often said to be around 4% per year.

That sounds amazing, right? That’s far more than you’ll get from any savings account these days, and that’s just the minimum return. There is, of course, the opportunity for it to be better.

The problem is that you’re not actually getting a 4% return, no matter what they say. A whole life projection I reviewed recently, one that “guaranteed” a 4% return, actually only showed a 0.30% return when I ran the numbers. That’s much less than what you’d get from a simple online savings account, even in this low-interest-rate environment.

I’m honestly not sure why they’re allowed to guarantee a return that you don’t actually receive, but I assume that the return IS 4% …before all kinds of fees are factored into the equation.

No matter what, though, YOU are not getting anywhere near the return they’re promising.

2. You’ll Be Negative for a While

Just above I said that the guaranteed return on that policy turned out to be only 0.30%. Well, that was only if the policyholder waited 30 years before taking any money out. The return was much lower, and often negative, for all the years before that.

See, when you pay into a whole life insurance policy, most of your initial premiums go to fees. There’s the cost of the insurance itself, other administrative costs, and of course the large commission that needs to be paid to the agent who sells you the policy.

What that means is that it takes a long time, often 10 years or more, just to break even on your investment. Before that, your guaranteed return is negative. And even after that, it takes a long time before the return starts to approach something reasonable.

Do you like the idea of investing in something that’s likely to produce a negative return for the next decade or more?

3. It’s Expensive

Whole life insurance is expensive in two big ways:

The premiums are MUCH higher than term life insurance for the same amount of coverage. It’s often as much as 10 times more expensive.
There are a lot of ongoing fees, most of which are hidden and undisclosed.

Remember that cost is the single best predictor of future investment returns. The lower the cost, the higher the likelihood of out-performance.

Typically, whole life insurance is one of the most expensive investments out there.

4. The Tax Savings Are Overstated

One of the stated benefits of whole life insurance is that it’s another tax-advantaged account. And that’s true to an extent:

Your investment account grows tax-free.
You can “withdraw” money tax-free.

Both of those have some big catches though.

First, while your money does grow tax-free, your contributions are NOT tax-deductible. In that sense, it’s kind of like a non-deductible IRA, without the full benefits of either a Roth IRA or a traditional IRA.

Second, the claim of tax-free withdrawals is incredibly misleading. What you’re actually doing when you withdraw money from your life insurance policy is lending money to yourself. You’re taking out a loan, and that loan is accumulating interest for as long as you don’t pay it back into your policy.

So no, you aren’t taxed on those withdrawals, but…

You are charged interest, which essentially replaces the tax cost (though it may be more or less).
In some cases you can withdraw too much money, in which case you would have to put money back into the policy (probably not part of your retirement budget) or allow the policy to lapse.

These kinds of complications come up all the time with policies like this, and are rarely explained up front.

5. It’s Undiversified

Diversification is a key characteristic of a good investment strategy. Essentially, it involves spreading your money out over a number of different investments so that you get the benefit of each without any one particular part of your investment portfolio being able to sink you.

Whole life insurance is inherently undiversified. You’re investing a significant amount of money with a single company and relying on both their investment skill and their goodwill to produce returns for you.

They have to be good enough active investment managers to outperform the market (unlikely). And they have to decide to credit enough of those returns to you, after accounting for all of the costs of both managing the investments and managing their insurance obligations.

That’s a lot of your eggs in one basket.

6. It Lacks Flexibility

Saving money on a consistent basis is the single most important part of investment success. So ideally you’ll be able to set up your monthly savings and continue them indefinitely, or even increase them over time.

But life happens, and flexibility is helpful when it does.

Let’s say that you lose your job. Or maybe you want to go back to school. Or maybe you receive an inheritance that means you no longer have to save as much.

If you’re contributing to something like a 401(k) or IRA, you can simply pause or decrease your regular contributions to free up some cash flow. In the meantime, the money you’ve already saved will continue to grow, and you can turn your contributions back on at any time.

You don’t have that flexibility with life insurance. If you don’t keep paying your premiums, the savings you’ve accumulated will be used to pay them for you. And when that money runs out, your policy will lapse.

Which means that any change in financial circumstances could mean you lose all of the progress you’ve made with a whole life insurance policy. There’s not much flexibility there to tread water until things get back to normal.

7. You Have Better Options!

If you ask just about any financial planner who doesn’t have a stake in selling whole life insurance, they will almost always recommend maxing out all other tax-advantaged retirement accounts before even considering life insurance as an investment, simply because they offer better tax breaks, more control over your investments, and often lower fees.

That means maxing out your 401(k), IRAs, health savings accounts, and self-employed retirement accounts first. And, even after that, considering things like a 529 plan or even a regular old taxable investment account.

If you’re not already taking full advantage of those other retirement accounts, using life insurance as an investment should be the last thing on your mind.

When Does Permanent Life Insurance Makes Sense?

For most people, life insurance will never make sense as an investment. But that doesn’t mean that permanent life insurance is useless.

Here are a few situations in which it can make sense:

You have a child with special needs and want to ensure that he or she will always have plenty of financial resources, no matter what.
You have millions of dollars potentially subject to estate taxes and you want to use life insurance as a way to preserve that money when it’s passed on to your family.
You’re already maxing out ALL other tax-advantaged accounts, you want to save more for retirement, and your income is high enough that the tax benefits offered by life insurance are attractive.

In all three of those cases, you’d want to work with a specialist who could design a policy to meet your specific needs, minimize fees, and maximize the amount of money that stays in your pocket. The whole life insurance policies most agents offer will not meet those criteria.

‘Too Good to Be True’ Usually Is

The whole life insurance pitch sounds good. Guaranteed returns, tax-free growth, tax-free withdrawals, and money available for any need at any time.

Who says no to that?

Of course, when something sounds too good to be true, it usually is, and this is no exception. Life insurance is typically not a good investment and in most cases you’ll be better off avoiding it.

Matt Becker is a fee-only financial planner and the founder of Mom and Dad Money, where he helps new parents take control of their money so they can take care of their families. His free book, The New Family Financial Road Map, guides parents through the all most important financial decisions that come with starting a family.

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