Introduction to Thinking About Life Insurance
Life insurance is an investment that people can choose to make – just like an investment in stocks and bonds. When making that investment in life insurance, one must ask the following questions: (a) what is the reason I’m making this investment? and (b) what return can I expect on my investment?
There is No Magic to a Life Insurance Policy
Life insurance companies are very smart. They have unmatched statistics upon which to base the cost of life insurance. So when a person invests in a “permanent” (discussed below) life insurance policy, part of each premium payment goes to cover the risk of death occurring in that year. The other part of the premium is invested inside the life insurance policy (typically in taxable bonds). That is important because there is no income tax on the earnings inside a life insurance policy. This allows the investment in a life insurance policy to grow exponentially to investments made by individuals (who have to pay tax on their bond interest each year and therefore have less to invest in the following year). If everything goes according to plan, the investments inside the policy grow as predicted by the insurance company when the amount of the premium is determined, and if the insured dies exactly when he or she was actuarially predicted to die, the insured’s family is paid a death benefit which consists of the investment in the policy by the insured plus the growth on that investment. In essence, the insured’s family is repaid with the insured’s own money (plus interest). How does the insured’s family “win”? Only if the insured dies much earlier than predicted – and that happens rarely. If the insured dies after predicted, the insurance company wins. And because life expectancy always increases over time, the insurance companies almost always win. There is no magic in life insurance.
Want to read more?
Please login below. If you don't have an account, feel free to sign up and get access to the entire WealthCAP HUB®.