Many people take out a life insurance policy in order to protect family members in case the insured person, usually the breadwinner, dies unexpectedly. In fact, life insurance policies are a great way of transferring risk from your family to your insurance provider.
Companies dealing in the life insurance business write so many policies that they are basically risk-neutral, so the companies don't need to bother about whether they have to pay out benefits in case a policyholder dies.
While this business is a win-win for both the policyholder and the insurance company, a variety of other advantages of life insurance policies also deserve attention:
1. Transfer of risk
Fatal accidents happen all the time and, unfortunately, have the potential to cause extraordinary hardship and could push a family into financial distress.
As such, it makes a whole lot of sense to insure the life (and earnings capacity) of the breadwinner in the family. Traditional term life policies basically provide a payment in the case an insurance condition is met, that is, the insured person has died.
2. Investment value
As opposed to term life policies, which frame the conventional understanding of life insurance, whole life policies combine protection benefits with a savings account.
With whole life insurance policies, your premiums consist of two parts: one part compensates the insurance company for the acceptance of insurance risk, the other part builds up a cash value.
This cash value builds up over time as you make your premium payments and the insurance company invests your money. The cash value is also guaranteed by the insurance company.
The bottom line: Whole life insurance products combine traditional life insurance with regular savings at a fixed premium price.
3. Benefit from tax advantages
The investment component in a whole life insurance policy is put to work by the insurance business and likely invested in stocks or bonds, or a combination of those.
However, the buildup in the savings account is tax-deferred, allowing policyholders to grow their investments more quickly compared to an account that would be taxed on an annual basis.
4. Life insurance policies can be collateral
The cash value of your whole life insurance policy is a hard asset, meaning it can be used as collateral and can be borrowed against.
This is a useful feature for a family that, for instance, has a whole life insurance policy with a decent cash value and needs to draw down money for a house down payment.
5. Structured savings approach
If you take out a whole life insurance policy, you are mitigating earnings risk in the case of death, but you are also saving money.
Many Americans save very little money on a regular basis. Based on data from the Federal Reserve Bank of St. Louis, personal savings as a percentage of disposable personal income stood at only 5.3% in June 2014 -- this is substantially below the 10%+ rates Americans saved in the 1960s and 1970s.
A whole life insurance policy holds you accountable and forces you to save at least a part of your premiums on a regular basis. Life insurance, therefore, can be a key pillar of your retirement savings.
The Foolish takeaway
Life insurance policies make a lot of sense when you are the main breadwinner in your family, which you would want to protect in case of your death.
In addition, whole life policies combine insurance protection with a savings account, which is a great way of saving methodically for long periods of time.