Buying Whole Life Insurance vs Term and Investing Difference
Why buy whole life insurance, the logic goes, when you can buy a term life insurance policy for so much less money and then invest the difference for a better return?
The thought behind this idea is that you’d have more money with a term policy and investing the difference than you would with a whole life policy.
Term life insurance will give you coverage for a certain “term,” such as 20 years for a low monthly price. Whole life insurance covers you for your “whole” life and will pay a set amount upon your death, but at the cost of thousands of dollars per year versus less than $1,000 annually for a term policy.
We asked a few life insurance and financial experts to run a financial analysis of such policies and investing the difference in cost for the cheaper term policy. Here are a few of their findings:
Almost $100,000 more with term and investing
Whole life and term offer different benefits, so it isn’t a strict apples-to-apples comparison, says Christopher Huntley, co-founder of JRC Insurance Group. Whole life offers guaranteed level premiums and coverage for life vs. up to 30 years of premiums for term life insurance.
That said, the savings can be substantial for term life customers who invest the difference from a whole life policy. For a 34-year-old man in good health who doesn’t smoke, here’s what a $500,000 policy would look like under numbers Huntley calculated:
- Pay premium of $399 per month.
- Over 20 years, it will cost $95,800.
- In 20 years, the whole life policy will build up a cash value of $111,245.
- Upon death, the policyholder’s family only gets the $500,000 death benefit — not a penny of the cash accumulation.
Term life with 20-year level premium:
- Premium of $22 per month, or $377 per month cheaper.
- It will cost $5,304 over the 20 years ($90,496 less than whole life).
- There is no cash accumulation, so if the policyholder decides to to cancel the policy, they get nothing back.
- If they don’t die after 20 years and still need coverage, they can convert the policy to a permanent plan at an unknown (but exponentially higher) premium. Or if they’re still healthy, could purchase a new policy.
If the term policy was bought and the annual savings was invested in the market for 20 years, and averaged an 8% after-tax return, the account would be valued at $202,027, or almost $100,000 more than the value of the whole life cash value, Huntley says.
He warns, however, as other experts did, that it’s a simplistic comparison and doesn’t take into consideration taxes at withdrawal or liquidity issues during the 20 years. Financial planning objectives play a big part, and an experienced agent should help you with your insurance needs, Huntley recommends.
$217,000 more in savings
- Annual premium is $17,520.
- After 20 years, his projected cash value is $525,625. That comes to a 3.72% annual return.
- A quote for a 20-year term life policy found an annual premium of $605.
That leaves a difference of $16,915 for one year, which if invested at historical returns and a 50-50 stock-bond asset allocation would get a 7.22% annual return on investment, Becker found.
Assuming an annual investment cost of 0.20% with index funds, in 40 years their investment would grow to $743,300, he says. That’s $217,625 more than the cash value of their whole life insurance policy, according to Becker.
Besides the likelihood of a better return, there are many reasons why traditional investments are better than a whole life insurance policy, Becker says. The tax benefits in a 401(k) or Roth IRA will almost always make retirement accounts more attractive than whole life insurance, he says.
“Whole life insurance is often touted as ‘tax-free,’ but that label is misleading,” Becker says. “While withdrawals can be tax-free if done correctly, those withdrawals are actually loans and accrue interest. That interest has the same effect as taxes do, which is to leave you with less money.
“Other investments also offer more flexibility, Becker says. “If something in your life changes and you no longer have as much disposable income, you can simply stop contributing to your traditional investment accounts,” he says.
“Meanwhile, the money you have already contributed will still be yours and will continue to earn returns. On the other hand, if you stop paying the premiums on your whole life insurance the policy will likely either lapse or will become less valuable.”
But does anyone do this?
Saying your going to invest the difference between whole and term life insurance premiums, and following through and doing it can be worlds apart.
In more than 28 years in the financial industry, Amy Rose Herrick, a Chartered Financial Consultant in the Virgin Islands, says she has never met a person who invests the difference consistently.
“Most folks stop the savings part for some reason and it stops there or they cannot afford the level of premiums on a whole life so the savings could not coincide to complete the equation in the first place with that level of outgo,” Herrick says.
She remembers years ago at a trade show where someone had a banner offering $1,000 in cash to anyone who could provide him at least 20 years of this as monthly or annual deposits to prove real results on buying term and investing the difference method. Herrick asked him if he ever had a taker, and he replied that he hadn’t and thought about raising the offer to $5,000 or $10,000.
Better off funding retirement?
There’s also the issue of what you want to do with your money. Do you want it as a death benefit or do you want to use it in retirement? You can do both, but something’s got to give.
Scott Stratton, a certified financial planner and founder of Good Life Wealth Management in Dallas, also ran quotes on a 30-year term policy and a permanent policy, each with a $1 million death benefit, for a 35-year-old man in Texas with a “preferred” rating. The term policy cost $975 a year and the whole life policy was $5,100 per year.
Investing the difference of $4,125 a year for 30 years at a return rate of 7% would grow to $416,926 in 30 years.
That’s well short of a $1 million death benefit, but it would go a long way toward funding retirement, “which for most people is a greater priority than leaving money to their heirs,” Stratton says.
“For most young and middle aged families, we are buying life insurance for ‘income replacement’ in case of the unlikely event that an individual passes away prematurely and is unable to provide an income for their loved ones,” he says.
Term life insurance is an excellent solution to that problem, he says. A permanent policy might be better if there was a need to fund a specific objective at death, Stratton says, such as paying estate taxes to avoid the sale of a business or farm, establishing a special needs trust, or to create a charitable trust.
“Outside of a clearly defined need for a permanent death benefit, most families will find a term policy to be sufficient and the lower cost will enable them to make better use of their cash flow,” Stratton says.
Aaron Crowe is a freelance writer who specializes in personal finance topics including insurance, real estate and kids and money. Follow him on Twitter @AaronCrowe or find his website at AaronCrowe.net.
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