Term vs Whole Life Insurance: Everything You Need to Know
Author: Oliver Dale | Wednesday, Oct 23, 2019
Do you have a family? Are you concerned about what happens to your loved ones if you should pass away?
Life insurance provides you with the coverage that pays out your beneficiary’s upon your death. We never know when we are going to go. By taking out life insurance, you protect your family against any unexpected circumstances surrounding your health and life.
However, is life insurance a good investment? Is it worth paying monthly premiums, or should you rather invest the money yourself in other assets for a better return?
Let’s unpack everything you need to know about life insurance as an investment.
If you’re considering life insurance as an investment to add to your portfolio, then you probably heard your stock broker use the term, “Buy term and invest the difference.” This piece of advice centers on the premise that term life insurance is the best form of insurance vehicle. Brokers have this opinion because it has the lowest premiums and frees up your money, allowing you to allocate it to other investments.
On the other hand, permanent life insurance allows you to accumulate cash value. However, this policy contains higher agent commissions and management fees. Many investment advisors will recommend that you avoid these fees and choose a term life insurance policy.
However, when your stock broker starts talking about life insurance as an investment, they are almost always talking about a permanent life insurance policy. The cash component of permanent life insurance allows you to invest and borrow against this money, using it to grow your portfolio.
In this article, we’ll look at when it makes sense to invest in both term and permanent life insurance.
Advisors recommend permanent life insurance as an investment for a few reasons. However, it’s essential to understand that these benefits are not unique to this financial vehicle. Many other investments offer similar, if not better, benefits – without the high commissions and management expenses involved with permanent life insurance policies.
However, advisors do recommend these vehicles for a reason, so let’s take a look at the top benefits on offer with a permanent policy.
The best benefit associated with a permanent life insurance policy is the tax breaks. You won’t have to pay the federal government any taxes on dividends, interest, or capital gain on your money until you withdraw funds from the policy. However, there are also methods to withdraws funds on a tax free basis.
This structure makes a permanent life insurance policy similar to a 401(k) plan, traditional IRA, and other investment vehicles that allow for tax-free growth in your money.
If you are already maxing out your annual contributions to your other retirement accounts, look into a permanent life insurance policy. It could give you an additional investment vehicle to add to your portfolio.
The critical difference between a term and permanent life policy is in the title of the asset.
A term policy expires after a set period, while a permanent policy can extend till after your death. Some financial service providers offer term policies that extend up to 30-years.
Therefore, you get to extend your policy to take care of your children and spouse after you pass. Typically, a term policy expires at the age of 65 or 70, similar to a traditional IRA.
Years from now, you may be in a tight position for cash, or find another high-yielding investment that you want to own. Fortunately, you can borrow from your carrier against the cash value of your permanent insurance policy.
If you try to borrow against a 401(k) or withdraw your funds before the maturity date, you can expect to pay penalties and charges. With a permanent life insurance policy, there’s no commissions or early disbursement fees when you choose to borrow against the funds in the account.
However, it’s crucial that you don’t treat your life insurance policy as a savings account. When you borrow against the cash value of your insurance, you have to pay back the insurance company with interest normally at a very preferred rate. Therefore, you need to take these payments into account in your financial planning for your retirement.
If things don’t go as planned, and you pass away before you repay the loan, your spouse and heirs will receive a smaller payout as the carrier needs to recover the funds,
In some cases, you may be unfortunate enough to experience a critical illness or life-threatening medical event before the maturity date of your policy. In such a case and if your carrier permits, you can withdraw anywhere between 25 to 100-percent of your death benefit while you are still living. Conditions such as heart attacks, strokes, and cancer all qualify for early withdrawal of your death benefit.
Receiving a lump sum from your policy helps you to handle the financial pressure associated with the medical expenses involved with your treatment. The only problem with this early withdrawal benefit is that your family might receive a smaller benefit after your passing.
However, in most cases, the policyholder gets to benefit from a more comfortable lifestyle, while making it less of a financial burden for their family. Some people may already have sufficient coverage with their medical insurance, making this benefit redundant.
Some permanent policies also don’t offer accelerated benefits, so check with your agent if you are expecting the insurer to include it in your policy. Taking out a permanent life insurance policy may make sense for high net-worth individuals that want to reduce their estate taxes.
When you invest in a term life insurance policy, you are opening a financial vehicle with a defined exit strategy.
All of the premiums you pay to the policy go to creating a death benefit that pays out to your spouse and children on your passing. Term insurance has no investment value because you can’t borrow against any cash value in the policy like you can with permanent insurance.
Even though there is no investment component involved with a term policy, you can consider it an investment. When you pass, your beneficiaries receive a large lump sum for relatively low monthly premiums.
Let’s use an example to explain how term life insurance works in the real world. If you’re a 30-year old female that’s a non-smoker and stays active. You should have no problem securing a 20-year term life insurance policy for less than $500 per annum in contributions.
If you were to pass away at 45-years old, after paying the $500 premium for 15-years, the beneficiaries of the insurance policy would receive $1-million, even though the woman only spent less than $7,500 in premium payments. The payout is tax-free to the beneficiaries, and they get a significant lump sum to help them through the financial difficulties associated with managing your passing.
Life insurance provides a significant return on investment if the policy comes into play. Many people that are still weighing in about the benefits of life insurance often complain about having to spend $10,000 over the next 20-years for something that they will never get to use. However, the return on investment for the policy benefits are well worth the money. Still, some may want to look at other avenues for growing their money instead.
What would happen if you invested 10,000 in the stock market over the next 20-years? Therefore, other investment vehicles can earn you more returns on your money. However, with life insurance if you pass away, your heirs receive a significantly greater financial windfall. It’s up to you to choose the best asset for your family and your future.
Now that we have a clear understanding of the mechanics behind a term insurance policy, it’s time to look at permanent insurance. Using our example above, the 30-year old female can expect to pay an annual premium of around $9,370. Therefore, the cost of a single year’s premiums to a permanent policy is just shy of half of the total 20-year term policy payments.
That’s a significant difference in financial contributions between the two policies. So, what are you getting for the additional payments and locking up your capital?
After owning the permanent policy for 5-years, the cash value of the asset is now $19,880, and total contributions toward the policy will amount to $46,850 that you pay in monthly premiums.
After 10-years of contributions toward your permanent insurance policy, the cash value is now $65,630, and total contributions toward the policy will amount to $93,700 from your monthly premiums.
After 20 years, the cash value of the permanent policy is now $181,630, and you have $187,400 in total premiums toward the policy.
However, if we look at the difference between the return on permanent insurance, versus buying a term policy and investing the rest in other assets, it paints a similar picture. If you invested the $8,890 in savings you make on your permanent policy premiums into the stock market instead of a permanent policy, what happens?
At an average return of 8-percent per annum, you end up with $480,806 before adjusting for inflation and account ting for taxes on your profits. That’s a significant difference, and you could do twice as well following the term strategy and investing your surplus cash.
However, it’s important to note that the permanent policy is a guaranteed return. Regardless of market conditions, you will receive your guaranteed payout. However, the market is not as robust, and it experiences ups and downs.
Achieving a stable 8-percent per annum is a challenge for the most talented fund managers, and asking them to sustain this figure is a lot to ask of any financial professional or fund manager. If the market experiences a crash and a decline, your assets may reduce alongside the depreciation in the market value.
No one can be certain about the future, and the performance of the markets. Uncertainty fuels the need for insurance, and it’s uncertainty that makes the company’s willing to take a risk on writing you a policy.
If you pass away and don’t have a handle on your investments, your heirs may lose out. The money in your assets could help them handle your financial affairs after passing. If you do choose to use any form of asset to secure your wealth for your family, use a will or a trust to distribute your assets.
There are two kinds of life insurance policies available. Term policies cover a fixed period, while permanent policies last until the policyholder dies.
As a financial vehicle, a life insurance policy pays out your heirs a death benefit on your passing. However, if you are using it as an investment vehicle, there may be better options for larger returns on your money.
The most significant benefit of a permanent life insurance policy is the tax breaks. If your current contributions to your 401(k) and IRA are maxing out, then a life insurance policy is another similar option.
However, if you are looking to maximize returns on your money, then they may not be the right vehicle for you. You will do better buying a term policy, and investing the difference in premiums into other assets like stocks. However, with a permanent policy, you can borrow against the cash value of your premiums paid to the financial services provider.
Before you select your insurance policy, sit down with your insurance agent or financial advisor. Ask the advisor to clearly explain the benefits of both policies, and make recommendations on which one suits your financial position and retirement goals.
Massey, Clark, Fischer is here to help you address all your questions and to help you select the best options for you and your family.