There is an ongoing debate on which is the more beneficial: Buy Term Life Insurance and invest the difference…or purchase Permanent Life Insurance instead? In this blog, Byron Udell, Founder and CEO of AccuQuote runs the numbers to see which type of policy really offers the most bang for the buck.
Ever since term life insurance was invented, the collective mantra has been: “Buy term life insurance and invest the difference.” This has been the conventional wisdom of many financial pundits, advisors, financial planners, stock brokers, and even certain insurance agents ever since.
The question is…does that advice make sense? Or could so many seemingly informed and intelligent people be simply misguided?
Let’s examine the facts. In this blog, we’ll do the math…and when it’s over, at the very least, you’ll have more information than when you started. AND you’ll be in a BETTER position to evaluate that mantra, and determine what type of policy is best for YOU.
The skinny on term life insurance.
Let’s start with Term Life Insurance. TERM life insurance, by definition, is temporary insurance. It’s typically sold as 10, 15, 20, 25, or 30-year level terms, meaning that, for instance, a 10-year term has ten years of level premiums…before the rate jumps dramatically in year 11 and goes up from there. 20-year terms have 20 years of level premiums, and so on. The longer the level term, the higher the annual cost (or premium), because the insurance company is, in essence, averaging out the increasing risk of death while delivering a predictable, level premium for the duration you choose. One major company recently introduced a new 35-year level term.
With a level term policy, once the term period expires, the rate jumps so high (sometimes, to as much as 10-20 times the level premium you HAD been paying), that most people simply cancel their policy. Now that begs the question: “What do you do at that point if you still need or want to maintain the coverage?”
Well, if your health is good, you may be able to buy another term policy, but if your health isn’t good…you may not. As we get older, everyone knows, we typically don’t get healthier. Springs start to pop loose. We begin leaking oil here and there. So there’s obviously no guarantee that a new term plan will even be available for you down the road when you reach the end of your current level term policy. And even if you CAN qualify for a new term policy when your old one runs out, rest assured that the premium will be considerably higher than the policy you bought when you were 10, 20 or 30 years YOUNGER!
What about Permanent Life Insurance?
Permanent Life Insurance, unlike term life, is NOT temporary coverage. It is designed to last a LIFETIME. A permanent policy certainly costs more, but there’s a reason for that, which we’ll get into in a moment. The premiums are usually designed to remain level for your entire life…and if it’s done right…and you pay your premiums each year, this permanent life policy will remain in force until you die. Permanent life insurance will ensure that your family will receive the policy’s death benefit!
I’ve been in the life insurance business for over 30 years, and in that time, I’ve learned a lot. And one of the most important things I’ve learned is that life insurance is NOT a “win/win” proposition between the insurance company and the people they insure. In fact, with almost every life insurance policy that’s sold…there will be a winner…and a loser.
So either YOU win…or the insurance company does. It’s just that simple.
Which type of policy is really better for my needs?
To answer that question, let’s run the numbers. First off, no matter which type of life insurance policy you choose…here’s the SECRET to winning the game of life insurance. The secret comes down to these SIX words: “Die with your policy in force.”
This “secret” works with either Term Life or Permanent Life insurance, but in order to do that with TERM insurance, you’d have to do something that you probably don’t want to do…you would have to die BEFORE you’re supposed to. Let’s fact it. Dying young is not something we typically plan or hope to do.
Assuming you die when you’re supposed to…around your life expectancy…in order to have your life insurance in force, so you can win the game…you have to own a policy that CANNOT be canceled by the insurance company before you die and won’t EXPIRE before you die, and that has a predictable, affordable, level premium that can never be raised by the insurance company in order to force you out before you die.
So what about “buying term life insurance and invest the difference”?
Let’s run the numbers. For our comparison, let’s use two of the most popular product categories: 20-Year Term Life and Guaranteed No-Lapse Universal Life.
For the sake of our example, let’s assume you’re a 45-year old male in excellent health, with a life expectancy of around 86…or 41 more years. The cost for a 20-year term life policy with a $500,000 death benefit is $600 a year. Universal Life has a lifetime guaranteed level premium and the same death benefit and cost $3,700 a year. Big difference, right?
If we were to invest that difference at, say 4 percent, after-tax (which is equivalent to earning about a 6-7 percent pre-tax return). It might not be easy, but perhaps doable. And at the end of 20 years, the value of that “side fund” would be $96,000.
But then what? You’re now age 65. Sure, your kids may be grown up, but you still have a spouse, and you’re probably not independently wealthy (unless you’re fortunate enough to be in the top 5 percent of the country). You’re still working, but that’s probably because you can’t afford to retire. And you still want your spouse to have some extra money to live on when you die…because $96,000 just isn’t enough these days.
Is $96,000 really enough to retire on?
If you had your term life policy and that “side fund” of $96,000, you might think, “Well, then I’ll just get another 20-year term policy, and I’ll be fine and dandy.” Let’s look at that. If you’re still reasonably healthy (of course, half the folks at age 65 aren’t…between cancer, heart disease, diabetes, etc.), but let’s say you’ve dodged all that. If you’re still healthy enough to qualify for a “standard risk” class, and want to replace that $500,000 of coverage with a new 20-year term life policy…that new policy would cost you about $14,000 annually!
Now, your $96,000 “side fund” would cover the cost of the first 7 years of that policy. But then you’re back to having to pay out of pocket…$14,000 a year. That’s a huge nut. And even so, that policy will last exactly another 20 years, bringing you to age 85. Now, let’s say you live to age 86…which is about the life expectancy of a healthy 45-year old…your coverage will have expired at age 85. Now, trust me, if you try to replace it at that age, you’ll be so shocked at the price…you might have a stroke right then and there. Forget about it.
Under that scenario, you would die without having any life insurance…and no one would get the $500,000 payout. To sum up, you will have paid $600 a year for the first 20 years (that’s 12,000, plus $14,000 a year for the next 20 years), that’s 280,000…for a total of $292,000 for 40 years of term life insurance. But you ended up with NOTHING because you died exactly when you’re supposed to…one year later at age 86.
Can you see why the insurance companies LOVE term life insurance?
How does a permanent life policy compare?
Again, if you’re a healthy 45-year old male and bought a permanent Universal Life policy with the guaranteed premium of just $3,700 a year (through age 85), you would have paid just $148,000 (over 40 years), plus another $3,700 for age 86, you’d be all in for $151,700. So if you then die…your spouse, or children, or grandchildren will collect $500,000 income tax free!
So you tell me. What makes more sense? Buy a term life policy and invest the difference (and spend multiple six figures on your policy insurance…only to die without any insurance), or buy a guaranteed Universal Life policy, with a level premium…for life…and die with life insurance totaling over three times what you paid for it?
It sure seems an obvious, easy decision to me. Yet, so many arguably well-meaning, yet misguided financial pundits would rather just tell you to “buy term life insurance and invest the difference.” Why? I don’t know. Perhaps they just haven’t actually done the math. I just know they couldn’t be more wrong.
Look, I’ve been doing this for over 30 years. I have hundreds of thousands of clients. And I’ve had thousands of clients die during that time. Not a single beneficiary of any of those death claims has EVER said to me: “We don’t need this insurance money. We’ll never be able to spend it all. So can you take some of this cash back and give it to someone who needs it more than we do?” It just doesn’t happen.
Remember, again, life insurance is NOT a win-win proposition. There’s always a winner…and there’s always a loser. And if you’re one of the winners…you don’t have to feel sorry for the insurance company. It’s actually all the people who bought policies and didn’t end up collecting (because their policies didn’t last long enough to be around when they died) that end up subsidizing the ridiculously high rates of return for those smart enough to own and keep their policies until they die.
There’s no question that term life insurance serves a valuable purpose and solves the problem of protecting your family temporarily…but not permanently. And there’s a good reason that term life insurance policies are cheap. But statistically, only 1.5 percent of them actually end up paying a death benefit, because they lapse or expire before you die.
Of course, the numbers vary depending on your age and health. If you have any questions, or want to see what the numbers look like for you, just contact AccuQuote.