Advantages & Disadvantages of Life Insurance
Life insurance offers several advantages not available from any other financial instrument; yet it also has disadvantages.
Advantages of Life Insurance
- Life insurance provides an infusion of cash for dealing with the adverse financial consequences of the insured’s death.
- Life insurance enjoys favorable tax treatment unlike any other financial instrument.
- Death benefits are generally income-tax-free to the beneficiary.
- Death benefits may be estate-tax free if the policy is owned properly.
- Cash values grow tax deferred during the insured’s lifetime.
- Cash value withdrawals are treated on a first-in-first-out (FIFO) basis, therefore cash value withdrawals up to the total premiums paid are generally income-tax free.
- Policy loans are income tax free.
- A life insurance policy may be exchanged for another life insurance policy (or for an annuity) without incurring current taxation.
Note: All of the above statements are generally true; however the tax benefits of life insurance have certain limitations which under the wrong set of circumstances can cause the tax benefits mentioned to be lost. Please discuss with your insurance and tax advisor.
- Many life insurance policies are exceptionally flexible in terms of adjusting to the policyholder’s needs. The death benefit may be decreased at any time and the premiums may be easily reduced, skipped or increased.
- A cash value life insurance policy may be thought of as a tax-favored repository of easily accessible funds if the need arises; yet, the assets backing these funds are generally held in longer-term investments, thereby earning a higher return.
Disadvantages of Life Insurance
- Policyholders forego some current expenditure to pay policy premiums. Moreover, life insurance is typically purchased for the benefit of others and usually only indirectly for the insured person.
- Cash surrender values are usually less than the premiums paid in the first several policy years and sometimes a policyowner may not recover the premiums paid if the policy is surrendered.
- The life insurance purchase decision and the positioning of the life insurance can be complex especially if the insurance is for estate planning, business situations or complex family situations.
- The life insurance acquisition process can be annoying and perplexing (e.g. Is the life insurance agent trustworthy? Is this the right product and carrier? How can medical underwriting be streamlined?).