Buy Term and Invest the Difference❠ⓠBut Do You?


life insuranceIf you’ve recently shopped for life insurance then you know that whole life insurance can be expensive. For this reason most people go with term life insurance instead. What we often hear is buy term and invest the differenceâ, but is that what most people do?

In truth, if you’re merely buying term life insurance to save moneyâ”and you never invest the savingsâ”you may be losing a lot of the benefit that term insurance provides.

Permanent life insurance versus temporary life insurance

Whole life has three advantages over term life and all three are big. First, whole life is permanent insurance, meaning you can keep it in force for the rest of your life (hence permanent). As long as you pay your premiums, the policy can’t be canceled.

The second is level premiums. When you buy a whole life insurance policy the premium will be set at the time of purchase. They will never rise for as long as you own the policy. That means that when you’re 50 you’ll be paying the same premium that you were paying when you bought the policy at age 25. If you’ve ever priced life insurance for a 50 year old you’ll know how great an advantage this is.

The third benefit is the policy’s cash value. With a whole life insurance policy, a portion of the premiums you pay are invested and grow over time. The money is typically invested in one or more mutual funds run by the insurance company. This is a form of forced savings that will increase steadily for as long as you own the policy. You can borrow against it, or you can even use it to pay the premiums in the future. Whole life is essentially a life insurance policy with an investment feature.

Term life insurance is temporary insurance. The use of the word term❠is just what it impliesâ”you’re buying the policy to cover a specific term. That term could be five years, ten years, 15 years or even 20, but it will expire at the end of the specified term. The insurance company can renew the policy, but when it does you’ll be charged a higher rate based on your age.

The term advantage

Term insurance is pure insurance, which is to say that there’s no investment provisions as is the case with whole life insurance. For this reasonâ”and for the fact that it’s temporaryâ”term life insurance is much cheaper than whole life insurance.

This is a major advantage by itself, but it also creates other benefits. If you have a young family and money is tight, you can buy more coverage at lower premiums than you can with whole life insurance. You can also carry a higher amount of coverage when your children are young and your need for coverage is higher. Once your kids come of age you can cut back on the coverage amount, and the premiums.

But do you actually invest the difference

Because of the large difference in premiums between term and whole life, it’s often recommended that you buy term and invest the differenceâ. If you do this faithfully over the course of your life, you can actually come out better than if you take a whole life insurance policy and rely on the company to invest the money for you. Yes, whole life contains an investment provision, but those investments are usually not the best when it comes to return on your money.

The insurance company charges fees on the investments and that reduces your return. They also invest your money in their own funds, which may not be anything close to the best performing funds available.

You would almost certainly do better investing on your own with a no-loan index fund held with a discount investment brokerage firm. In theory, you will do better with term insurance if you instead invest the difference between the money you would pay in whole life premiums and term life premiums. If you don’t invest the difference, the term advantage is largely lost.

What usually happens

Unfortunately, it’s very likely that very few people actually invest the difference when they choose a term life policy over a whole life one. When buying term, we’re mostly looking to save money. The money saved isn’t invested in mutual funds or any other investment. It’s used to cover other living expenses.

There may be little choice. If you have a young family, not only is your need for life insurance greater than it has been or will be at any other time in your life, but your expenses are also higher. There’s childcare, babysitting expenses, medical care (and family medical insurance coverage), and college savings plans to fund. You’re looking to save money where ever you can, and term life insurance is one way to do it.

But next time you’re out shopping for life insurance and you hear the phrase buy term and invest the difference think long and hard about whether or not you’ll actually do it. If you don’t think you will, you may want to take a close look at whole life insurance as an alternative.

photo by epSos.de

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Written by Kevin

With backgrounds in both accounting and the mortgage industry, Kevin Mercadante is professional personal finance blogger, and the owner of OutOfYourRut.com, a website about careers, business ideas, money and more. A committed Christian, he lives in Atlanta with his wife and two teenage kids.

Kevin

With backgrounds in both accounting and the mortgage industry, Kevin Mercadante is professional personal finance blogger, and the owner of OutOfYourRut.com, a website about careers, business ideas, money and more. A committed Christian, he lives in Atlanta with his wife and two teenage kids.

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