"Forced savings" refers to any automated withdrawals you have set up to save for the future, such as withdrawing a certain amount from each paycheck and transferring it to your 401(k), savings account, or other retirement account. Because the money is automatically withdrawn, you don't have to worry about setting it aside.
Because permanent life insurance policies include a cash value component, they are sometimes considered a type of forced savings. But the fact is that life insurance and savings accounts are different products that serve their own purposes — and you should include both products as part of your larger financial portfolio, not one or the other.
What is permanent life insurance?
All permanent life insurance products have a death benefit and cash value that grows on a tax-deferred basis. Although whole life insurance is used synonymously with permanent life insurance, whole life is actually a type of permanent life insurance.
Permanent life insurance lasts until you die, or an average of 110 years, which is why it's more expensive in the early years of policy, but the older you get it becomes less expensive. According to Mark Williams, CEO of Brokers International,"in the early years of overpayment, the cash value put inside the policy earns interest and you use that bucket of money to offset the cost of insurance when you're older."
Permanent life insurance is different than term life insurance, which covers a 10, 20, or 30-year period. If you die during that period, your beneficiaries get your death benefit. Because term life has no cash value and expires, it's less considerably less expensive than permanent life insurance.
The big difference between the various types of permanent life insurance policies is how they manage the cash value. Whole life insurance stands out from other types of permanent life insurance because it guarantees the exact same payment for the life of the policy. The cash value from whole life insurance is invested with the life insurance portfolio. Other permanent life insurance products, like variable life insurance, have cash value invested in the stock market.
Due to its cash value component, permanent life insurance can function as an investment and wealth-building tool. You can the cash value for things such as paying your children's college tuition, funding a business, or purchasing a second home. Some financial planners have also suggested that permanent life insurance is a good tool to close the racial wealth gap.
Most people use the cash value to fund their retirement, paying themselves a monthly income when they stop working.
A good financial plan includes both savings and life insurance
Some have suggested that consumers simply buy term life insurance and invest the rest in the stock market. However, some permanent life insurance products are invested in the stock market, and the big disadvantage to term life insurance is that it expires.
Term life insurance is like renting a home instead of owning it, because it expires after a specific time and must be renewed — usually at a higher rate. Permanent life insurance is like equity in a home due to the cash value. With permanent life insurance, you can start with a smaller death benefit and increase it over time while earning cash value.
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Some financial planners recommend a combination of permanent and term life insurance.
For example, say you have $200,000 in permanent life and $300,000 in term for 20 years. At the end of 20 years, the term life insurance policy goes away, but you've earned cash value on the $200,000 permanent policy. And if you can't afford a permanent life insurance policy, you can get a term life policy that can be converted to a permanent policy.
And when it comes to investing, Williams says you should be maxing out other investment plans such as your 401(k) before using permanent life insurance as an investment tool. (But if you don't have access to a qualified plan like an employer-sponsored retirement account, permanent life insurance is a good tool.)
Williams says you should have a reason to buy life insurance, because you're paying for it. In other words, your financial situation should dictate your need for life insurance.
And don't forget that your life insurance needs change as you age, and you'll need to consider children, marriage, divorce, retirement, and caring for aging parents.
To maximize the benefits of life insurance, it's wise to include a financial advisor, accountant, and estates attorney in your decision-making process to ensure you have proper coverage that adapts as your life changes.