Life Insurance vs Savings Account: Key Differences

If you want to provide financial protection for your loved ones should you pass away unexpectedly, you have a few options. You could buy life insurance, put money aside in a savings vehicle, or do both.

With life insurance, you pay premiums to the insurance company, and if you die while the policy is in effect, the company pays a death benefit to your family. Some policies also come with a savings component, known as the cash value, which you may be able to access while you’re alive.

With a savings account, on the other hand, there are no monthly or annual premiums (or death benefits). You could contribute as much or as little as you want to the account and may generally withdraw the money at any time for any reason. (Keep in mind, however, that savings accounts may limit you to six withdrawals per month.)

If you’re trying to decide whether it’s a good idea to invest in life insurance or a savings account, the answer is probably both. Here’s what to consider. 

Understanding Life Insurance and How It Works

There are numerous types of life insurance, but they generally fall into two main categories: term life insurance and permanent life insurance. 

Term Life Insurance

Term life insurance is a relatively low-cost type of life insurance that is designed to cover you for a set term, hence its name. For example, you might purchase a 20-year or 30-year term life policy. You pay a premium each month (or year), and should you pass away during that time, a benefit is paid out. If you don’t die within the time frame specified in your policy, it expires with no payout. 

Permanent Life Insurance

Permanent life insurance lasts your entire life and often includes a cash value component, which you may withdraw or borrow against while you’re still alive. A portion of your premium payment goes into the policy’s cash value, which accrues either interest or market returns based on other investments. The cash value grows on a tax-deferred basis. Because the insurer is guaranteed to pay a death benefit to your loved ones (assuming all premiums are paid), permanent life insurance rates are considerably higher than those for term life insurance.

Benefits of Life Insurance

Whether you opt for term or permanent life insurance, there are multiple benefits to purchasing a life insurance policy. 

Pays Out a Death Benefit

When you have life insurance, your loved ones may receive a lump sum of money if you die while the policy is active. This could make up for the loss of your salary and cover future living expenses for your family, such as mortgage payments and your children’s college tuition. It could also provide a financial cushion for unforeseen expenses they may encounter.

Term Insurance Is Relatively Low Cost

Depending on how much coverage you need and your age when you apply, you may only have to pay a small monthly fee for a term life insurance policy. In the event of your death, the payout could be significantly more than you paid for the policy.

Cash Value Can Help You Save

With some types of permanent life insurance, such as whole life, your premiums are split to pay for a death benefit and an interest-bearing, savings-like account called the cash value. Your cash value could earn returns — plus dividends, if any — which may later be either withdrawn or borrowed against for future expenses, including retirement. (It is important to discuss withdrawals and/or loans with your financial advisor or insurance agent because withdrawing your cash value may collapse the policy.)

Risks of Life Insurance

Purchasing life insurance also comes with some downsides. Here are some to consider.

Cash Value Can Be a Weak Investment Vehicle

The rate of return on the cash value component may be lower than simply investing the money in a retirement or other investment account. Also, if you choose to redeem your cash, there may be fees involved, which could eat into your returns.

Whole Life Insurance Can Be Costly 

Whole life insurance tends to be expensive, often in the range of hundreds of dollars per month. Early on, many of your premiums typically go toward fees, not your cash value. To see the full benefits of whole life insurance, you generally have to continue paying high premiums for at least 5-10 years, often longer. The same may be said of other types of permanent insurance.

Term Life Insurance Can Be Costly Under Certain Circumstances 

Life insurance premiums are determined by your medical profile and age. As a result, you could typically pay more for term life insurance coverage if your profile includes anything that could potentially increase your risk, such as being older and/or having any health conditions. Remember, the premium is based on the likelihood that the death benefit may be paid out.

Harnessing the Cash Value of Your Life Insurance Policy

If you have a permanent life insurance policy with a cash value, a portion of your premium is credited to the policy’s cash value and may be used while you’re alive. There are a number of ways you may be able to tap this benefit. For example, you may be able to:

• Take out a loan that borrows against your policy’s cash value when you need money.

• Let the cash value grow and use it to supplement your income in retirement.

• Terminate — or “surrender” — your policy and receive the entire cash value (minus surrender fees).

Understanding Savings Accounts and How They Work

A savings account is a deposit account that’s designed for holding money you don’t need right away. These accounts are options from traditional banks, online banks, and credit unions, and they pay interest to help your money grow. Interest is expressed as an annual percentage yield (APY). An APY tells you how much interest you expect to earn on your money in one year. 

The funds in a savings account are liquid. However, they are generally less accessible than the money in a checking account. Checks can’t be written against them, and you’re often limited to six withdrawals or transfers per month. If you exceed the bank’s transaction limit, you could be charged a fee.

Savings accounts are federally insured up to $250,000 per account holder, so you may not lose your money (up to the limit) even if the bank goes belly up.

Benefits of Savings Accounts

Here’s a look at some of the benefits of opening a savings account.

Earn Interest on Your Deposits

The money you keep in a savings account earns interest and compounds, meaning you earn interest on the interest that’s added to the account, helping your money grow over time. Online high-yield savings accounts typically have higher interest rates.

Recommended: Guide to High-Yield Savings Accounts

Early Access to Your Money

With a savings account, you may access your money when you need it. There are no waiting times or holding periods, and you may not have to pay any surrender fees or other fees to withdraw your funds. 

Freedom to Miss Payments

With a savings account, you could create a “forced savings” plan by setting up a recurring automated transfer from checking to savings each month. However, if money gets tight, you may simply cancel the transfer without any consequences. If you miss payments on a life insurance policy, by contrast, the policy could be canceled, and you could potentially lose everything you’ve paid in thus far.

Downsides of Savings Accounts

Savings accounts also have some drawbacks. Here are some to keep in mind.

Low Returns

Traditional savings accounts generally pay a relatively low APY. While high-yield savings accounts could pay more than 11 times the national average for savings accounts, these accounts generally don’t pay enough interest to hit long-term savings goals, such as retirement or a child’s college education. For that, you may want to consider riskier investments such as stocks or mutual funds.

Taxes

The interest you earn on a savings account is considered taxable income. Life insurance cash value accounts, on the other hand, generally grow tax-free.

No Death Benefit

Unlike life insurance, there is no death benefit with a savings account. This means if you die before you have had enough time to save enough money for your family and do not have life insurance, they could be left in financial distress.

Savings Account vs Life Insurance Account

Here are some of the major differences between a savings account and a life insurance cash value account.

Do I Still Need Life Insurance When I Already Have Good Savings?

It may be a good idea to have life insurance even if you already have good savings. A general rule of thumb is to have at least 10 times your annual income in life insurance coverage. Many people don’t have that much socked away in a savings account (or other savings vehicles). As a result, your savings may not be enough to support your family, especially if you die young or have multiple dependents. 

Recommended: How Much Does the Average American Have in Savings?

Can You Combine Both Accounts?

Life insurance vs. a savings account generally isn’t an either-or proposition. Many people have a life insurance policy and a savings account (as well as a retirement account). A savings account allows you to put aside money for a rainy day, while a life insurance policy covers you in ways that a savings account generally cannot. In addition, it’s a good idea to have a retirement account to maximize your financial security.

The Takeaway

Life insurance and savings accounts are two ways you could build financial security for your family. It’s generally a good idea to keep at least three to six months’ worth of living expenses tucked away in a separate high-yield savings account to cover unexpected expenses or loss of income. 

When it comes to life insurance, you may want to get a policy that would pay at least 10 times your annual income. By balancing savings with life insurance, you could keep your family covered now and into the future.

If you’re looking for the best return on your savings, it generally pays to shop around. With Lantern by SoFi’s online banking marketplace, it’s easy to compare high-yield savings accounts based on APY, fees, and balance minimums. 

Lantern can help you compare online savings accounts and find today’s best rate.