Insurance is traditionally structured to safeguard individuals and businesses against unforeseen risks. However, certain insurance products in Australia have an embedded opportunity for wealth creation. Understanding how to use these insurance products as a form of investment in Australia is a great way to reap the benefits of protection and wealth accumulation in one package.
This article discusses how you can use insurance as a form of investment in Australia.
How Does Insurance Work as an Investment in Australia?
There’s only one kind of insurance that can work as an investment, and that’s life insurance. Also, while there are two types of life insurance, term and permanent, only the latter can be used as an investment due to its potential to grow cash value.
So, how does permanent life insurance work as an investment in Australia?
Permanent life insurance works as an investment by creating a reserve called “cash value” for the policyholders where a portion of their premium goes in. This cash value is the only portion of the policy that earns interest and is available for the policyholder to withdraw or borrow against in emergencies.
Term life insurance policies don’t offer cash value benefits. However, they’re generally cheaper than permanent life insurance. Because of their cost, they leave policyholders with extra money to invest in traditional investment programs.
How to Use Insurance as an Investment in Australia
Though primarily designed for protection, some insurance policies in Australia include a saving or investment component that makes them even more valuable to the holders. Here are some ways you can use insurance as an investment in Australia:
Cash Value Accumulation
In some insurance policies, like whole life insurance, a portion of the premium the policyholder pays goes into a cash value account. This cash value accumulates over time, earning interest or returns within that period.
Policyholders of these kinds of insurance can access their cash value or the accumulated interest at any time.
Endowment Policies
Endowment insurance policies are structured to provide security and a lump sum of money to the policyholder at maturity or death. This form of insurance can work as an investment for the policyholder if it matures before their death, as they receive the face value of the policy or the accumulated cash value.
Dividend Payments
Some participating whole life insurance policies pay dividends to policyholders. These dividends are returns from the insurance company’s investment performance.
Participating life insurance policyholders can choose to receive their dividends in cash, reduced premium, or reinvest it to enhance the policy’s cash value.
Loan Provisions
Some life insurance policies, like permanent life insurance, allow policyholders to take loans against the cash value of their policies. This provides liquidity for the holders, which they can reinvest in a traditional investment program.
Superannuation Funds
In Australia, superannuation funds can be considered an insurance-based investment. This is because while the funds the policyholders contribute are for retirement purposes, they’re put into investment programs that provide returns. Policyholders can choose from various investment options, including conservative, balanced, or growth portfolios.
By selecting a more aggressive investment program in your superannuation funds, you can potentially increase the returns on your retirement savings.
Also Read: Certificate of Deposit: Definition, Advantages & How to Invest in CD
Benefits of Using Insurance as a Form of Investment
You can derive many benefits from using your insurance policy as a form of investment. Here are some of them:
Financial Protection
The primary purpose of insurance is to provide financial protection against specific risks, such as disability, critical illness, or death. This ensures the policyholders and their beneficiaries receive due compensation in case of an unforeseen circumstance.
Savings and Investment Growth
Some insurance policies, like whole life insurance or endowment policies, accumulate cash values over time. This cash value has the potential to grow through interest or investment returns, providing policyholders with a savings component within their policy.
Long-Term Planning
Using insurance as an investment lets you plan long-term projects like education and retirement and execute them effectively. This usually works best with endowment and other life insurance policies that offer a lump sum settlement at maturity.
Diversification
Using insurance as an investment provides a combination of protection and wealth building, as it allows you to diversify your financial portfolios. This is more suitable for people who want risk mitigation and savings or investment programs.
Access to Funds
The cash value attached to your insurance policy is a great source of emergency funds. You can take loans against the cash value without forfeiting the policy.
Disadvantages of Using Insurance as a Form of Investment
While you can benefit greatly from insurance-based investments, you should also consider the drawbacks. Here are some of them:
Lower Returns than Traditional Investments
Insurance-based investments often offer lower returns than traditional investments like stocks, bonds, or mutual funds. This is because their major focus is on providing insurance coverage, and the cash value reserve is only a subcomponent of the program.
High Fees and Costs
Insurance policies come with fees attached, which might reduce the investment return. Some policies require you to pay administrative fees, mortality and expense charges, and other fees, which makes the costs higher than what’s obtainable in traditional investment programs.
Limited Flexibility
Insurance products, especially those with investment components, are less flexible than traditional investments like mutual funds, exchange-traded funds, etc. They place heavy restrictions on withdrawals and charge heavy penalties for early termination, thereby limiting the liquidity of their products.
Opportunity Cost
The funds put into insurance-based investment products could be put into higher-returning investments such as stocks, real estate, and more, or alternatively, be put into cheaper insurance products and invest the remaining in a traditional investment program.
You must consider this opportunity cost, as you’d have to choose between tying up your funds in an insurance-based investment and putting them all in an investment that could earn you more.
Also Read: Exchange-Traded Funds (ETFs) Have Which of the Following Features?
Factors to Consider Before Using Insurance as an Investment
Before you take up an insurance-based investment, here are some important factors you must consider:
Investment Goals
The first thing you must consider when choosing an insurance-based investment is your investment objectives. Are you looking for financial protection, wealth building, or a mixture of both? Or are you looking for long-term growth, capital preservation, or a combination of both?
Permanent life insurance policies are expensive but provide financial protection and a savings or investment component. However, taking up term life insurance policies, which are generally cheaper than permanent life insurance, leaves you with extra funds to invest in traditional investment programs.
Risk Tolerance
Assess your risk tolerance level, as insurance policies with investment components have varying levels of risk. You must consider whether you’re comfortable with the risk associated with insurance-based investment products.
Cost and Fees
Another thing you must consider is the costs and fees associated with insurance-based investments. These insurance products often come with fees and charges that can impact your cash value or overall returns.
Therefore, you must try to understand the charges involved, from policy premiums to management fees and other expenses.
Liquidity Needs
You must also consider your liquidity needs, as some insurance products often restrict access to funds, especially in the early years of your subscription. Evaluate whether the insurance product aligns with your short-term and long-term liquidity needs.
Tax Implications
Taxes are charged on insurance products in various formats, depending on the type of insurance and the investment structure. Understanding the tax implications of your chosen insurance-based investments is essential.
Also Read: Make Your Money Work for You: 10 Ways to Earn Extra Cash
Conclusion
Building a profitable investment is one of the many reasons people buy insurance products. However, only a few insurance products, like whole life insurance and endowment policies, make it easily accessible. Therefore, you must understand how to make the most of their opportunities.
Hopefully, this article has given you insights on how to use insurance as a form of investment in Australia.
