Almost everyone needs life insurance at some point in their lives. There has been significant debate about whether, if you can afford it, it is better to buy term and invest the difference or buy permanent insurance. In my view the answer is determined by simple facts and math.
Buying vs. Renting
When people ask me whether they should buy or rent their home the answer is normally “how long do you plan to live there?”. The term vs. permanent question is analogous to renting vs. buying. Renting makes sense if you plan to move or may be transferred in the next couple of years. Otherwise rents go up and you are building no equity. Once you purchase a home the price is fixed. While it is true that property taxes and insurance may go up, those costs are reflected in rents as well. If one knows when they are going to die, term insurance is perfect. Of course no one knows when they will reach room temperature.
Most people who are intellectually honest would submit that they don’t know when their time will come but at least need to protect their family during their prime earning years. In the old days, term insurance was renewable annually and the cost went up every year. Today, term is now fixed for 10, 20 or 30 years. At the end of the term it can be renewed, but at a much higher and sometimes prohibitive cost. If someone tells me they are completely certain that they will not need insurance past age 65 term is the least expensive option. Or is it?
First, no one knows with certainty what their financial situation will be five years from now, less yet twenty or thirty years. For discussion purposes, lets agree that a person will not need insurance after a certain age. Term is similar to car insurance in that you pay for coverage and if you do not use it, you lose your money. Most insurance is structured to pay only when something bad happens. We pay our premiums knowing this but we do it anyway because we want the peace of mind that if our house burns down, it will be replaced or if we die, our families will be financially secure. Permanent insurance costs far more initially – but – over time it provides cash returns whether you die or not. In addition the cost never increases.
The question of which form of insurance is more expensive comes down to the time value of money. No one can say with any certainty the precise moment they will no longer need their life insurance. If their “term” is up and they still need coverage they may not have any. Here is a fact: The vast majority of term policies never pay out. This is why the premiums are so low. The high lapse ratio should tell you something. Whole life is built for your whole life. The insurance company fully expects the policy to pay out and is priced accordingly. Having spent 31+ years as an insurance agent I have seen many instances where a client needed insurance longer than planned and beyond the point where their term policy had expired. Sometimes they had less in retirement than they expected. Other times they had business arrangements or loans that would leave their heirs with debt. Even if there is no economic need, insurance proceeds are tax free and can help pay some or all of the taxes that are deferred in 401k or IRA accounts. The potential scenarios are many. If you are banking on not needing insurance on your life after age X, you may be in for a surprise and no options due to age or health.
Invest the Difference Argument
Hypothetically, if all minds agree that a point in time in the future exists where life insurance is no longer needed: you can invest the difference between the cost of permanent insurance and term insurance into some type of investment. What type of investment exists that can outpace inflation, after tax and without market risk? Nothing – Permanent insurance issued by a top rated, 100-year-old, multi billion dollar company will provide respectable returns, over time with no market risk and in a tax-favored environment. Unlike a home, that once paid off has ongoing expenses, permanent insurance does become “paid up”. Paid up insurance is a rock, a pillar of financial security that has no maintenance or ongoing expenses. Instead, permanent insurance provides the opposite – increasing cash values even after it is paid up. Of course, these policies must be structured correctly with enough cash buildup to sustain itself. One last thought: A life insurance program does not have to be all term or all permanent. A good plan is one constructed by an experienced professional in consultation with the client.
About the Author:
David Disraeli has been in financial services for over 31 years. He is an author, speaker and financial advisor and the president of The Personal CFO, Inc. During his tenure, David has been an insurance agent, portfolio manager, stockbroker, Certified Financial Planner and financial analyst.