What is Life Insurance?
Life insurance is confusing because sometimes it seems like an insurance product and other times it seems like an investment product. This is because, back in the 1970s, life insurance products became a popular tax shelter. But eventually people went too far–placing a “life insurance” label on what was clearly an investment account–to get the tax benefits. In response, Congress passed laws to prevent the most extreme cases. As a result, today there are life insurance policies that work like plain old insurance and others that have a mix of insurance and investment characteristics but are careful not to upset the IRS.
Term insurance policies are pure insurance policies with no investment component. These policies would exist no matter what the various tax laws might say because they are purely insurance products filling a basic human need for safety and security. This is the kind of insurance Benjamin Franklin and Will Rogers had in mind with the following quotes:
“A policy of life insurance is the cheapest and safest mode of making certain provisions for one’s family.”
– Benjamin Franklin
“A man who dies without adequate life insurance should have to come back and see the mess he created.”
– Will Rogers
Permanent life insurance (whole life, universal life, etc.) typically includes investment features. This makes sense when you think about it. If you have a 20-year term policy to cover the years when you have dependents, then you are really just focused on providing back-up income in case something unexpected happens to you. In contrast, people with permanent life insurance at 70, 80, or 90 years old are planning (estate planning) for their expected future death from natural causes. By having their investments grow inside a life insurance policy the final payout can avoid estate taxes. This is why permanent life insurance policies typically have investment characteristics.
More specific details on each type of policy can be found at the following links: