Should you buy life insurance as an investment? Here's why it doesn't make sense for everyone

Purchasing life insurance can be critical for someone with young children at home or a partner depending on them to make ends meet. It can also be useful if you have a large debt, like a mortgage, or don't want your family to have to cover funeral expenses after you die.  

A term life insurance policy covers an individual for a set number of years before expiring, usually after between 10 and 30 years. But permanent life insurance, including types like whole life insurance, lasts for the remainder of the policyholder's life. It may also build cash value that can be used to pay premiums, cover long-term care or even as collateral for a loan.

Permanent life insurance policies generally carry higher premiums, though, and some involve managing various investments and fees. So they're not the right choice for everyone.  

Here's what you need to know about permanent life insurance and how to tell if it's the right type of policy for you.  

• What is permanent life insurance?
• Is a permanent life insurance policy right for you? 
• How to use permanent life insurance as an investment 
• Have a financial plan before considering permanent life insurance
• Bottom line

Permanent life insurance policies generally come in two parts: A death benefit, which pays out when you pass away, and a cash-value component, where money grows in a tax-deferred account that can be accessed while you're still alive.  

Whole life insurance is a popular form of permanent life insurance that typically comes with fixed premiums. It can be eligible for dividends, or a return of a portion of the premiums you've paid for it. Costs can be higher, however: A 30-year-old nonsmoker could pay as much as $472 a month for a $500,000 whole life insurance policy, according to data from Policygenius. That's compared to $34.53 a month for a 30-year term insurance policy with the same payout.

Think seriously about why you want life insurance. While permanent life insurance can enable you to leave a financial legacy, a term life policy can make more money available to spend and invest while you're still alive.  

Whether you're looking for term or permanent life insurance, CNBC Select has rounded up the best options.

Guardian Life is highly rated for financial strength and has both permanent and term life insurance. It actually offers term life policies that can be converted to permanent at any point in the first five years without any extra costs. 

State Farm, which also offers whole life insurance policies, boasts high ratings for customer satisfaction and financial strength.

Before choosing a policy, you should determine if you need life insurance in the first place.

"The conversation of whether or not someone needs life insurance has to do with dependents," says Brian Kaplan, a certified financial planner and senior vice president at Lenox Advisors. At its core, life insurance is meant to replace someone's income when others rely on it, whether that's a partner, children or someone else. 

If life insurance is the right move, look at your entire financial picture to determine the right type. While income can be a big factor in how much you can afford in monthly premiums, you should also consider your other savings and investments and their tax advantages. For younger people who aren’t high earners, using permanent life insurance as an investment may not make sense. 

"It's really for the higher income earner on the younger side, who is paying a lot of money in taxes and looking for another place to park dollars with a little bit more tax efficiency," Kaplan says.  

Permanent life insurance can create value you can tap into while you’re still alive — to pay for your children's college tuition, make improvements on your home or even fund a dream vacation. It could be a good option for those who have reached the caps on their investment accounts, like 401(k)s, IRAs, and 529 plans. 

Here's how to access the cash value you've built in your life insurance policy.

Tax-free withdrawals 

Although the rules vary by plan, you may be able to draw cash from your permanent life insurance policy. Withdrawals are typically tax-free up to your policy basis, which is the amount you've paid in premiums so far. (Any withdrawals above basis, however, are subject to income tax.)

There are disadvantages to drawing on your policy: It reduces the amount of the death benefit and, if there isn't enough cash value to fund the policy, the coverage can lapse.

Consult with your insurer to fully understand the implications of withdrawing from your specific policy.

Borrowing against your policy 

You may also be able to borrow against the policy with a lower interest rate than you'd get with a personal loan (and you can skip the approval process). The funds can be used for any purpose but there are some risks: If you die before you’re able to fully pay the money back, it could lower the death benefit your beneficiaries receive or even cause the policy to lapse. 

There are several financial tools you should take advantage of before considering a permanent life insurance policy as an investment, according to Kaplan. 

One of the most critical is an emergency fund. He recommends saving six months' worth of expenses in a high-yield savings account. Lending Club LevelUp Savings is one of CNBC Select's top picks for its strong APY and ATM access.

UFB Portfolio Savings also stands out for its similarly high APY and no minimum balance requirements.  

From there, Kaplan asks his clients about their 401(k) plans. "The people that should look at [permanent life insurance] are maxing those out,'" he says.

While permanent life insurance can have tax advantages — like tax-free withdrawals and death benefits — Kaplan says anyone considering a policy should already be taking full advantage of their retirement accounts, including 401(k)s and IRA plans. In 2023, employees can contribute up to $22,500 per year to a 401(k) plan, with those 50 and older eligible to contribute an additional $7,500. For IRAs, the annual limit is $6,500, with an extra $1,000 available to those 50 and older.  

Kaplan also suggests using 529 plans to save for a child's education and maxing out contributions to a health savings account before taking out a permanent life insurance policy.  

Whether to get life insurance or not depends on your lifestyle and financial goals. If you're considering permanent life insurance as an investment tool to access while you're still alive, make sure you're maxing out other tax-advantaged accounts first.  

At CNBC Select, we work with experts who have specialized knowledge and authority based on relevant training and/or experience. For this story, we interviewed Brian Kaplan, a senior vice president at Lenox Advisors in New York City and a certified financial planner.

At CNBC Select, our mission is to provide our readers with high-quality service journalism and comprehensive consumer advice so they can make informed decisions with their money. Every personal finance article is based on rigorous reporting by our team of expert writers and editors with extensive knowledge of financial products. While CNBC Select earns a commission from affiliate partners on many offers and links, we create all our content without input from our commercial team or any outside third parties, and we pride ourselves on our journalistic standards and ethics.

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