Today’s guest post is by Glenn Cooke, a life insurance broker and president of LifeInsuranceCanada.com who believes in an educational approach to life insurance rather than a product sales approach. In the post he urges readers to take a closer look at the numbers behind the conventional wisdom of buy term and invest the difference.
Proponents of buy term invest the difference advocate strongly against purchasing whole life insurance. For those unfamiliar with the idea, it suggests that buying cheaper term life insurance and investing the difference in a mutual fund is a better financial option than purchasing a whole life policy and cancelling it at age 65 for the cash values. The strategy itself is rooted back in the 1980’s when the life insurance industry was promoting whole life insurance to consumers as some type of savings vehicle. The strategy often provokes a strong emotional reaction against life insurance companies. What many people may not realize that the biggest promoters of this concept even today are actually life insurance companies who use it to sell term life insurance and mutual funds.
Nevertheless, back in the 1980’s with interest rates where they were and with the products we had available back then, a pretty strong ‘numbers’ case could be made. But that was like 25-30 years ago. Things change. Is this emotional argument that got foisted onto consumers by the insurance industry still valid? Let’s have a look at the numbers today.
Before I do so, let me just state clearly – I have no preference either way. I do however believe in looking at the actual numbers once in a while, rather than just blithely continuing to parrot what everyone else has been repeating for 20 odd years without ever checking their facts.
It’s also important to appreciate that the buy term invest the difference argument is NOT a numbers game. It depends on your assumptions. What do you think is the correct long term interest rate over the next 15-20 years? 8%? or 3%? Or somewhere in between?
OK, lets get to the numbers. I’m using the Compulife® database for my premium information, the database used commonly by insurance brokers as well as what powers the quotes on my website. And we’re going to look at a male, nonsmoker age 45 purchasing $100,000 of life insurance. For the term policy I’m going to use Equitable Life’s 20 year term at $286 per year. For the whole life I’m going to use a whole life policy from BMO Life with premiums of $1276 per year.
Case 1: (Assume 8% rate of return, no taxes on earnings.)
- Term Case: If they buy the term and invest the difference at 8%, at age 65 they cancel the insurance and have $48,928 saved.
- Whole Life Case: If they buy the whole life and cancel at age 65, they will have a cash value of $27,160 (less a minimal amount of tax).
The term is $20 G’s better than the whole life. Case closed – it’s a win for buy term invest the difference.
But wait. All is not as it appears. Back in the 80’s one could convince consumers that 8% was a nice conservative rate of return and lead into both a term insurance and a mutual fund sale. Today? Clearly not all consumers are going to buy into the idea of an 8% rate of return over the long term.
So lets try the same numbers at 3% rate of return.
Case 2:(Assume 3% rate of return, no taxes on earnings.)
- Term Case: Buy term and invest the different at 3% and cancel their policy at age 65, they’ll have $27,399.72 saved.
- Whole Life Case: If they buy whole life and cancel at age 65, they’ll have a cash value of $27,160 (less a minimal amount of tax).
Really? At 3% rate of return the two products are almost identical! Actually, it turns out that they’re not identical. At this crossover point, the whole life actually has substantial benefits over the term policy.
- First, the 3% we just assumed you’d earn with your term and invest strategy? Not guaranteed. The cash value on that whole life policy? Guaranteed. We’re comparing a non-guaranteed rate of return with a guaranteed cash value. Win for the whole life policy. Clearly in today’s environment some Canadian consumers are going to be interested in the equivalent of a guaranteed 3% rate of return – even when compared a higher non-guaranteed rate of return.
- Secondly, what if we change our mind and don’t cancel the policy? If you bought the whole life, your premiums remain at $1276 for the rest of your life. If you bough the term life insurance, you now have to take a medical exam and buy a new whole life at age 65, for premiums of about $3500. Win for the whole life policy of over $2000 a year for the rest of your life.
- But there’s a third option. The whole life policy allows you to stop paying premiums and take a smaller policy of $46,500 for the rest of your life, no further premiums due. By comparison with the term policy, if you took your $27,000 in savings from your term policy, you could buy a 10 pay whole life policy of $25,000 for about $2500 per year for 10 years – which roughly burns down the money you just saved. Stop paying premiums and keep the coverage, the whole life policy will provide you $46,000 of lifetime coverage, the term option, about $25,000. Win for the whole life policy of $20,000 when you pass.
So now the ‘numbers’ seem like the whole policy is actually a better buy. But there’s some downside to this as well. With the term policy, despite the drawbacks mentioned above, the cash is liquid whereas it’s not easily accessible inside the whole life policy. Does that matter? Maybe it does, then again, for some folks maybe it doesn’t. And for many consumers, paying the higher premiums of whole life simply may not be feasible.
As you can see, it’s not as clear cut as it’s often made out to be. What product is ‘best’ often lies in the underlying assumptions. High interest rate or low? Guarantees vs. non guarantees? Higher premiums or lower premiums? As different people have different preferences and tolerances, so to do we have different solutions for different people. It’s not nearly as simple as buy term invest the difference and believe you’ll be better off financially in the future.