Life insurance is riddled with myths and confusion as part of an overall investment portfolio. I will answer some of the misconceptions in this article that tend to circulate and provide valuable information to help consumers make some rational decisions about purchasing this important personal product.fbn insurance offers excellent info on this.
In an earlier article (“Why Buying Term and Investing the Difference is One Big FAIL!”), I addressed why buying term insurance and investing the difference is generally inferior to simply buying a life insurance policy for cash value. Buying term and investing the difference is the norm for the vast majority of people, ensuring that the idea of creating more wealth through a structured investment program never materialises. In addition, term policies can become painfully expensive in the middle ages, resulting in people losing their policies or, if they bought a standard term insurance for a long period of time, say 10 to 20 years, they might find that their wellbeing would make them uninsurable or the cost beyond their means when the time comes to replace the policy expired. And they often find that the returns on their portfolio’s investment component are not close to equaling the life insurance coverage they need.
The second issue deals with taxes: the “invest the difference” part of the equation will almost certainly have tax consequences: a tax bill will result in unrealized capital gains and dividends for non-retirement investment accounts. What that means is that the capital gains on those sales result in a tax liability, as the fund manager buys and sells stocks for the portfolio. Similarly, the reinvested dividends are also taxable. In both cases, about January of each year you will receive IRS Form 1099s in the mail which will display the profits and dividends and must be paid for at the time of taxes. You won’t have any money in your wallet in both cases but you’ll have more to pay in taxes. That will potentially lower the return rate.
Whole life insurance policies have no tax problem either: dividends accumulate tax-free, and the cash value can be paid out on a tax-free basis later in life. And, of course, if paid out, the death benefit is not subject to income tax (though it might be subject to estate tax).
I now keep on with other life insurance misconceptions. Perhaps the biggest is that there’s no need for young, single people to buy life insurance. The famous financial services media created and promulgated this misconception that life insurance is meant to protect the ability of survivors to stay financially solvent in case a breadwinner dies prematurely. Therefore, according to this misconception, there is no need for life insurance for young people, who are usually single.