Is Life Insurance a Waste of Money?

Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts

Updated on August 14, 2023

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Overview of Life Insurance

Life insurance is a legally binding contract between a policyholder and an insurance company. The insurance company promises to pay a predetermined sum of money, known as the death benefit, to the designated beneficiaries upon the death of the insured person.

There are two general types: term life and permanent life. Term life insurance provides coverage for a specific term, such as 10, 20, or 30 years. If the insured individual passes away during this term, the death benefit is paid to the beneficiaries.

Otherwise, the policy simply ends with no payout.

Conversely, permanent life insurance offers coverage for the entire lifetime of the insured. These policies also feature a cash value component that accumulates over time and can be borrowed against or withdrawn during the policyholder's life.

The choice between term and permanent life insurance depends on various factors, including financial circumstances, life stage, and long-term financial objectives.

Why Life Insurance Is a Valuable Investment

Security for Unforeseen Circumstances

Life is inherently uncertain. This reality can be daunting, and the idea of leaving loved ones in a difficult financial situation can cause considerable anxiety.

A life insurance policy can help mitigate these fears by ensuring that in the event of an untimely death, there will be a financial safety net for those left behind. This means that mortgage payments, education costs, and everyday living expenses can be covered.

Thus, not only does life insurance provide monetary support, but it also delivers peace of mind, allowing policyholders to live their lives knowing that they have made provisions for their family's financial future.

Variety of Options to Suit Different Needs

Term life insurance, for example, provides coverage for a specified term, making it a cost-effective solution for those wanting maximum coverage over a set period, often aligning with their working years or the term of a mortgage.

On the other hand, permanent policies such as whole and universal life insurance offer lifetime coverage and include a cash value component, acting as both an insurance product and a financial asset.

Whole life insurance has fixed premiums and a guaranteed cash value growth, while universal life insurance offers flexible premiums and potential for greater cash value accumulation based on market performance.

This diversity allows individuals to choose a policy that suits their specific needs, making life insurance a versatile tool in personal financial planning.

Potential for Cash Value Accumulation

Certain types of life insurance policies, such as whole life or universal life insurance, have a cash value component that can grow over time. A portion of each premium paid towards a whole life or universal life policy contributes to a cash value account that grows over time.

This cash value account can act as a source of loan in times of need, it can supplement retirement income, or it can even be used to pay policy premiums at a later stage.

This component introduces an element of forced savings into life insurance, making it more than just a death benefit.

Tax Benefits

In most cases, the death benefit paid to beneficiaries is income tax-free, which means the full benefit amount will be available for use without any deductions.

Additionally, any cash value growth in a permanent life insurance policy is generally tax-deferred. This means you won't have to pay taxes on the growth until you withdraw some of the cash value, giving the investment an opportunity to grow more rapidly.

Also, if loans are taken from the policy, they are typically tax-free, providing an efficient way to access your funds.

Peace of Mind and Financial Stability for Loved Ones

The death of a loved one is an emotionally overwhelming time, and the added financial stress can make the situation even more challenging. Life insurance helps to alleviate this financial burden by ensuring that those left behind will not be left in a precarious situation.

In essence, life insurance provides a financial safety net, ensuring that loved ones can maintain their standard of living, meet their financial obligations, and focus on their healing rather than worrying about finances.

In this sense, the cost of the premiums can be viewed not just as an expense but as an investment in the financial stability and well-being of one's family.

Why Life Insurance Is a Valuable Investment

Common Misconceptions About Life Insurance

“I Can Get Rich Quick”

Many people erroneously view life insurance as a sort of lottery—a tool for instant wealth.

In reality, the primary purpose of life insurance is not to serve as an investment or wealth creation vehicle, but rather to provide financial protection to the insured's dependents in the unfortunate event of the insured's death.

Life insurance is meant to replace the insured's income, settle their debts, and cover end-of-life expenses, ensuring that their loved ones don't face financial hardship upon their passing.

This fundamental misunderstanding often leads to unrealistic expectations from the policy, resulting in dissatisfaction and the perception that life insurance is a waste of money.

“It Is Expensive”

Studies have shown that people, particularly younger individuals, often significantly overestimate the cost of a life insurance policy.

For instance, term life insurance, which offers coverage for a specific period, is often more affordable than people anticipate. Its cost depends on various factors, including the insured's age, health status, and lifestyle.

Younger, healthier individuals can secure substantial coverage for relatively low premiums. Therefore, understanding the actual cost versus perceived cost can help individuals make more informed decisions about purchasing life insurance.

“Only Breadwinners Need It”

While it's essential for the primary income earner to have coverage, the value of a non-income earning spouse, such as a stay-at-home parent, shouldn't be overlooked.

The services provided by a stay-at-home parent, like childcare, home maintenance, transportation, and more, carry substantial economic value. If the stay-at-home parent were to pass away unexpectedly, the surviving spouse would have to cover these costs.

Life insurance can provide the necessary funds to help maintain the family's lifestyle and cover these additional expenses.

Best Practices to Maximize Your Life Insurance

Understand Your Needs

This involves a careful evaluation of your financial situation, including your income, expenses, debts, assets, and the number of dependents you have.

Consider the financial impact your loss would have on your family. How much would they need to maintain their current lifestyle? How would they handle ongoing expenses, such as mortgage payments, school fees, or retirement savings?

In addition to these immediate costs, consider long-term factors like inflation and changing economic conditions.

Financial advisors or online life insurance calculators can be valuable tools in estimating your coverage needs, ensuring you neither over-insure nor under-insure yourself.

Choose Wisely

Different types of life insurance serve different needs. As mentioned, term life insurance provides coverage for a specific period and is generally cheaper, making it a good choice for young families with tight budgets.

On the other hand, whole and universal life insurance policies provide lifetime coverage and include a cash value component that grows over time.

These policies can serve as both a risk cover and a long-term investment, making them suitable for individuals seeking a more comprehensive financial planning tool.

Understanding the features, benefits, and costs of each policy type can help you select the most appropriate one for your circumstances.

Review Your Policy Regularly

As your life changes, so too should your life insurance policy. Significant life events, such as getting married, having children, purchasing a house, or transitioning to retirement, can dramatically change your coverage needs.

By reviewing your policy annually or following any significant life event, you can adjust your coverage to match your current circumstances, ensuring your policy remains effective and beneficial over time.

Customize Your Coverage

Life insurance riders are optional add-ons that allow you to customize your coverage to fit your specific needs better.

There are a variety of riders available, such as the disability income rider, which provides a regular income stream if you become disabled, or the critical illness rider, which pays out a lump sum upon diagnosis of certain illnesses.

While these riders come with additional costs, they offer enhanced coverage and can significantly boost the value of your policy.

Understanding your potential risks and discussing available rider options with your insurance advisor can help you optimize your coverage.

Mind Your Health

Your lifestyle and health significantly influence your life insurance premiums. Insurers often categorize policyholders into different risk classes based on factors such as age, weight, smoking status, and overall health.

Leading a healthy lifestyle—maintaining a balanced diet, exercising regularly, abstaining from smoking—can significantly improve your risk profile and potentially lower your premiums, allowing you to obtain the same level of coverage for less money.

Pay Premiums on Time

Failing to do so can lead to policy lapse, leaving you and your loved ones without coverage.

While many insurers offer a grace period during which you can pay the due premiums and keep the policy active, it's not a good practice to rely on this provision. Setting up automatic payments or reminders can help ensure you never miss a premium payment.

Be Honest

If you misrepresent or omit critical information about your health, lifestyle, or family medical history, the insurance company may deny a claim or cancel your policy altogether.

Not only can honesty prevent such issues, but it also helps ensure that your premiums accurately reflect your risk profile, making your policy more cost-effective in the long run.

Work With a Reputable Insurer

Look for companies with strong financial ratings, positive customer reviews, and a solid track record of paying claims.

Researching and comparing different insurers, asking for recommendations, and consulting with an insurance advisor can help you select a company that's reliable, reputable, and suitable for your needs.

Best Practices to Maximize Your Life Insurance

Final Thoughts

Life insurance is an agreement between a policyholder and an insurance company, providing a predetermined death benefit to designated beneficiaries upon the insured person's death.

Life insurance is not a waste of money because it provides security for unforeseen circumstances and offers a variety of options to suit different needs. Some life insurance also comes with cash value accumulation and tax benefits.

By dispelling common misconceptions about life insurance, such as viewing it as a means to get rich quickly, considering it too expensive, or who really needs it, individuals can better understand its true purpose and affordability.

To maximize your life insurance, you should understand your needs, choose the right policy, conduct regular reviews, customize your coverage, stay healthy, pay on time, and practice honesty in the application.

By understanding its benefits, dispelling misconceptions, and following best practices, individuals can make informed decisions about life insurance and ensure that it is, indeed, not a waste of money.

Is Life Insurance a Waste of Money? FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.

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