Life insurance is considered one of the most important investments one can make. However, it comes in many faces, and is categorized in two main types: term life insurance and permanent life insurance. Term life insurance, or term assurance, does not have an investment component, unlike the latter. Hence, permanent life insurance is popular as it is not only considered a financial protection against early death, but also a rewarding retirement investment.
However, banking on permanent life insurance for your retirement is riddled with many pitfalls. Here is why you shouldn’t use life insurance as a retirement investment.
It is expensive
Permanent life insurance premiums are higher than most other retirement investment accounts. Nevertheless, most people view this as a positive aspect as it guarantees high returns. However, this is not always the case as a sizeable portion of the premiums go into servicing the policy’s fees.
Considering that you can get similar or even better rewards from other retirement investment accounts for a much lower contribution, permanent life insurance is anything but convenient. Unfortunately, most agents never mention this to their clients, and this pitfall actually motivates unsuspecting customers to buy the policy.
The returns are not guaranteed
Another factor that makes permanent life insurance all the more appealing is the ‘guaranteed’ returns. These policies tend to offer the highest returns, some as high as 4%. However, as mentioned earlier, there are many fees that have to be serviced, and most of the times the returns rate tends to be much lower than proposed. Besides, providing high returns rate would not be good for business for the insurer. Once all fees are factored into the equation, a typical return rate of 4% can dip to less than 1% and stay like this for years. This is why it is always advisable to do the math before committing to a life-long life insurance plan.
Returns are not immediate
In addition to low return rates, permanent life insurance policies do not offer immediate returns. Most permanent life insurance policies are usually so expensive that it takes years to clear all the hidden fees. As such, the insurer deducts everything from your premiums for the first several years to get your policy on its legs. In essence, from an investor’s perspective permanent life insurance is an investment that takes years just to break even. However, most clients are not aware of this since life insurance is a long-term investment. Besides, agents never mention the high hidden costs.
It isn’t Liquid
While most people bank on permanent life insurance for their retirement days, sometimes financial emergencies do arise at a young age. When this happens, it helps to have a ready source of money that can get you out of your hurdles. Unfortunately, there are many obstacles (some of which are absolute) to getting money out of your life insurance policy.
First, the fact that your account will be negative for the first decade or so means that you cannot withdraw from it for that period. Second, there is a fee to be paid if you decide to cancel the policy and withdraw the money. The fee is considered a surrender charge, and it can be substantial especially with high-end permanent life insurance policies. What’s more, if you decide to borrow against your policy, you have to pay interest as explained below (yes, you have to pay to use the money you put into your policy).
It is not entirely ‘tax-free’
The seemingly high return rates, coupled with the offer of a tax-free retirement investment plan, makes permanent life insurance a must-have for many unsuspecting clients. However, although it is true that the savings are tax-free, there is still a fee to be paid when you withdraw money from your policy. In fact, taking out some money from your insurance policy is not exactly withdrawing but rather borrowing. This is because every dollar you ‘withdraw’ from your insurance account has to be paid back, and it accumulates interest like a loan.
What’s more, some expensive insurance plans tend to have interest rates that are higher than tax deductions. This pitfall is so deep that a large ‘withdrawal’ can result in a lapse once the accumulated interest outgrows the accumulated savings.
It is not flexible
Permanent life insurance is permanent in many aspects. One of these aspects is that you have to pay your premium on a timely basis, every time. Unlike regular investment accounts such as IRA, there is no option of lowering your premium rate or halting payments for a while. This comes as a rude shock for many when financial problems arise, and more so considering how expensive permanent life insurance premiums are.
Even worse, what happens once you cannot pay your premiums is even more shocking. Since there are fees that have to be catered for, your accumulated savings are deducted to pay for your premiums once you default on the monthly payments. And, once the savings are exhausted, your policy lapses and you lose all your hard-earned cash.
Complicated terms and conditions
Like good sales people, life insurance agents are very convincing and persuasive. However, they are not always honest. Likewise, most permanent life insurance policies are not always transparent. One of the main downsides of a permanent life insurance policy is that there are usually many and high hidden fees. These fees, as mentioned earlier, tend to be so high that they put you in debt for years, even decades before your investment can break even.
Another downside is the complicated language in the policy’s terms and conditions. The hidden limitations often come as a big surprise later on when one has to take some money out of the insurance policy.
There are better options
You have to get a life insurance policy at the end of the day, but a retirement investment is also necessary. For insurance, you can always go with a less complicated and affordable term life insurance policy. And, for retirement, there is a wide range of options that are less expensive and more rewarding than permanent life insurance. Most of these investments beat the high fees and lack of flexibility and liquidity, and they tend to be transparent in their terms and conditions.