So what are some of the practical means that you can take to protect your children’s future?
Saving money and investing is key to building a strong financial future for your kids. But how should you do this? Sometimes something as simple as putting a little bit of money away in savings can help start the process of securing your children’s financial future.
Typically if you were to approach financial advisor they would try to sell you on a number of different products that they claim would help give your child a firm foothold in your absence.
Unfortunately, many of those products are suboptimal; not only are they structured in ways that are forbidden for us as Muslims but their financial returns really aren’t that great.
Some will tell you to just start a savings account and allow the interest to accrue. But what you’re doing is loaning a bank your money at interest either through a simple savings account or by purchasing a bond, then allowing them to use that money while you are only paid half a percent of interest if you’re lucky. so not only are fixed income instruments impermissible because their loans at interest, but the returns are bad as well.
So what are some of the other things that would typically be offered to you to help provide for your children’s expenses in your absence?
Well in addition to simple fixed income instruments and savings accounts your financial advisor may ask you to open up an education account like a Coverdell ESA or a 529. They will tell you that part of a strong financial plan is a well-diversified portfolio. And that is true. But regardless of whether you put fixed income in an education account or not, you’re still going to have to deal with the morally problematic nature of loaning money at interest and quite frankly the bad returns.
So are there any other options that would both preserve your capital for your kids as well as give you better returns?
One product that is often offered to young parents along with a healthy dose of Doom and Gloom about the inevitability of death is life insurance. Advisors will say that You HAVE to have a life insurance policy and that it’s the only way you’ll have something left over for your family when you die. Now there are a lot of different life insurance products out there that are structured in different ways and the differences between them can be a bit confusing. Some advisors take advantage of this confusion and ramp up the emotional baggage to sell you on something that they’re going to take a commission from.
In this article, we will compare whole life insurance policies to investments. Because the average term life policy is 25 years, and we are projecting for retirement after 30+ years, term life doesn’t apply to our scenario. We want to focus on life insurance products that will have a long-term benefit, as well as, cash value after 30 years, namely whole life products.
So do you absolutely have to have life insurance in order to leave behind something substantial for your children?
The answer is no, and I’ll explain to you why.
Why Life Insurance is Not The Only (or Best) Way Secure your Children’s Future
Without getting into the Fiqh rulings of Life insurance, here’s why life insurance doesn’t make sense. Life insurance is a form of insurance that pays out a sum of money either on the death of the insured person or after a set period. It remains active for a specific term, a time, then it expires. So if you are 25 years old and buy a 25-year policy for example, then you reach 50 years of age and haven’t died then you’re out all the money you placed in that policy. Essentially, the insurance company says “Give me your money and I will guarantee that if you meet certain stipulations, I’ll give you some money back later. But if you don’t, you don’t get anything”. They then take your money and invest it in a pool that does stuff like buy Tesla shares, then pay dividends and profits to their shareholders.
Another type of life insurance, called “Whole and Universal” insurance combines term insurance with some form of savings or investment that can be cashed out later. The insurance company says: “You have a need, I have a need, let’s pool our money. When we put all our money together if any of us have a claim that needs to be paid, we’ll pay it out of the investment pool, otherwise, we’ll just invest the money we’ve gathered.” What they don’t tell you is that they get a sizable commission for selling these policies to you. This means that your policy takes an instant hit once you open it. Additionally, the returns on these policies are poor.
Now regardless of which type takes your insurance premiums, you as the consumer have no say in how those premiums are invested. What does that mean? It means that your insurance pool managers will probably look for safe, relatively low-risk investments. That means they’ll be looking for interest-bearing fixed income instruments, as well as equities that have low volatility. All in all, your money will most probably be invested in something clearly impermissible investments 9 times out of 10.
Could we create a permissible insurance policy? Well sure, if we structure a company as a Mutual that only invests in Shariah-compliant investments. Does one exist? For many of us, not at this time.
For many of us, especially those of us that do not have access to true Takaful products, this is something which is unavoidable. As I have explained in other articles is an issue that has to be dealt with at the regulatory level. While at times we have to buy insurance products to protect our property or our health, that doesn’t mean that we’re off the hook for making an ethical decision in how we go about doing that.
But even when we have the option to buy an insurance policy, do we really need one?
Halal Investment VS Life Insurance
What if instead of buying an insurance policy, you invested that money in a retirement account?
Let’s take the example of Ahmed and Omar. Both of them are concerned for their children’s future, but Ahmed is sceptical about life insurance and doesn’t like the idea of giving away his money for others to use in ways that he is opposed to morally. Omar, on the other hand, claims that it’s not his problem and that all he is concerned about is how much money is left for his kids when he dies.
Ahmed decides that he’s going to invest his money. He sees that the average return of the market is around 7.5%, so he decides he’ll open a retirement account that invests in Shariah-compliant equities. He deposits 20k in his account to start and over the next 35 years invests $5,500 yearly. The average monthly amount he’d invest would be $458. By the time Ahmed is 65 and wants to retire, he would have 1.2 million dollars in his account, before taxes.
Omar, on the other hand, decides to buy an insurance policy. He buys a policy with a payout of one million dollars, that he makes an initial payment for upfront to the tune of several thousands of dollars, then pays for monthly over the next 35 years. With an average monthly payment of $896 dollars a month, this policy would cost him $322,560. The insurance policy would have accrued a cash value of $617,104 after 30 years.
Ahmed has more than double the amount Omar has, and at a lower cost to himself as well. Best thing is, we’ve had complete control over our money and invested it in companies with halal activities. The same can’t be said for the insurance policy.
5 Reasons Why Investment is Better than Life Insurance
Here are the top five reasons why investing in a retirement account is better than life insurance:
- A retirement account is more straightforward: you can fund it then buy stocks, mutual funds, gold, and real estate.
- In some countries, your contributions to your retirement account are tax deductible. Your contributions to life insurance are a personal expense and are not deductible. Eventually, the policy will cost you more
- With a retirement account, you have access to your money at any time. With insurance, you don’t (depending on the policy) and even then you’ll need at least 10-20 years to build up reasonable cash value you can withdraw, but those can be hit pretty hard by taxes when you withdraw them.
- Retirement accounts are low cost. life insurance policies can be quite costly, with upfront fees usually going towards your agent’s commissions, and investment fees are pretty steep (3% vs. 1.5% in an IRA)
- A retirement account is always yours, while if your insurance policy lapses you’ll have to pay surrender charges, meaning that you’ll not only lose your benefits but much of the cash balance as well (if any).
The No.1 Reason to Invest vs. Buy Life Insurance: Seeking Barakah
This short analysis bolsters what we know from the Sunnah of the Prophet.
In a hadith collected by Ibn Maja, he said:
“Whoever sold a property and did not place its equivalent price into something similar, then its most likely than not Allah will not bless that transaction.”
What does the hadith mean? It means that if you take a large sum of money that was earned permissibly and invest it into something that is risky or impermissible, the blessing of Allah (Barakah) will be voided from that transaction. Likewise, when we invest in halal investments, we can be assured that we are using our hard earned halal wealth to build even more halal wealth. With insurance policies, it is not that certain. With this quick review of investment vs. life insurance, the former makes the most sense both spiritually and financially.
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About the Author
Joe Bradford is an American scholar of Islam. He holds a Master of Islamic Law from the University of Medina, and has studied traditionally in the Muslim world for the past 20+ years. Working as an Ethical Finance Advisor for individuals and institutions, Joe is one of the few experts on issues involving Muslims and Finance in North America. As a co-founder of MyWassiyah.com, he has leveraged his extensive knowledge of Islamic Inheritance to create a world-class product that bridges the gap between traditional Islamic knowledge and the requirements of the US legal system.