A Twist On an Age-Old Argument
It’s been debated for generations. Term life insurance versus permanent life insurance? Which one is “better”? In recent years a new concept has crept into the debate: rather than choosing a permanent life insurance policy, you purchase a lower cost term insurance plan and invest the difference.
This approach may be well suited for some people, but for others it may not make sound financial sense. You’ll want to make an informed decision, so it’s best to discuss your needs and your options with an insurance professional. Before you make up your mind, you’ll want to consider the following questions:
Which Type of Life Insurance is Best for You?
No matter what you may have read in financial advice columns, there is no one “best” type of life insurance. What’s best is what is best for you. Life insurance is not a “one size fits all” product. There is a wide range of permanent life insurance products to choose from, including whole life, modified premium whole life, survivorship whole life, and universal life, each with its own particular benefits, which can be tailored to suit your particular needs.
Term life insurance may be right for younger people with limited means and few financial responsibilities. It can also serve as a short-term, stopgap means of pure protection. Later, as life changes occur, the term policy can be converted to permanent insurance. When all is taken into consideration, you may find that a combination of permanent and term insurance is best for you.
How Long Do You Need Life Insurance Coverage?
Most would say they need the security of life insurance for their entire lives. Life insurance can help pay off a mortgage, fund a college education, take care of final expenses, offset the loss of the insured’s income, and allow a family to continue its standard of living. Both term and permanent insurance can provide those benefits, but which one can do it most efficiently over the course of a lifetime?
With a permanent product such as whole life, premiums are fixed — they can never be increased by the insurer — and your coverage can never be canceled provided premiums are paid when due. With term policies, your premiums are set for a predetermined period (one year, five years, etc.), then increase in subsequent years. With a premium increase at each renewal, the cumulative cost of term over the course of several decades may well bypass that of a comparable whole life plan. In addition, with some term policies, you may be required to submit evidence of continued good health with each renewal. This may put you in danger of being uninsurable when the term coverage is up for renewal.
Do You Prefer Renting or Owning?
The well-known analogy of a term policy as “renting” and a permanent policy as “owning” life insurance is a good way to illustrate their true values. When you rent a house, you receive all the benefits of living in that house. However, when your lease is up, you have built up no equity. Even if you’ve paid rent for thirty or forty years, when you move out you leave with as much value as you started with — zero. The same is true of a term insurance policy.
Conversely, with a permanent policy, you build guaranteed cash values that you may tap into through loans.1 In addition, as an owner of permanent insurance, you maybe eligible for dividends,2 if and when they are declared by the insurance company. These dividends may be used in a number of ways, including applying them to purchase paid-up additional insurance, which can increase your overall coverage with no additional out-of-pocket expense.
Invest the Difference in What?
Investing wisely is a key factor in determining the success of “buy term and invest the difference.” If you choose term insurance, you’ll have to decide where to invest your leftover money. Products such as mutual funds and individual stocks and bonds are options. Of course, with these types of assets your return will vary based on market conditions; and when you redeem your shares, they may be worth more or less than you originally paid.
If you are risk averse or very close to retirement, this volatility may not be right for you. Also, capital gains, if any, are taxable when distributed. CDs are a less risky option, but they could have withdrawal restrictions and their return may not be as high as you’d like. With permanent insurance, your policy builds guaranteed cash value that in the long-term could accumulate to a significant sum. These funds accumulate on a tax-deferred basis, and can be conveniently accessed through policy loans that are usually non-taxable.1 Permanent life insurance has another key tax advantage: the proceeds that flow to beneficiaries are generally free from federal income tax.
Will You Be Able to Invest Regularly?
There’s no question that systematic investment of a fixed sum over the long-term can help build your nest egg. “Pay yourself first” is a great strategy, but will you have the means and the discipline to carry this out? Unfortunately, when it comes to planning for the future, good intentions don’t always translate into positive actions. Some people are so overwhelmed by the financial burdens of everyday life that they neglect to put money aside for their future. Without the “invest” component, you’re left with a term policy that has no capability of accumulating funds for the future. With a permanent policy, you have both the peace of mind provided by the death benefit and a source of contingency funds in the form of guaranteed cash values. 1
How Will Timing Affect Your Investments?
This is an important concern. While investing the difference may be a good option for some, you must also take into consideration what negative influences on the market can do to your investments and what your risk tolerance is. A down market like we have experienced twice in the last decade can wipe out our portfolio or a least severly diminish it’s value, and your principal is also at risk. Even though permanent life insurance is primarily designed for it’s death benefit feature, it also has the advantage of minimum guarantees.
The Choice is Up to You
For some, “buy term and invest the difference” may be a legitimate option. While for others, permanent insurance is the way to go. Your decision is a personal one, based on your family’s means, needs, and goals. The insurance and financial decisions you make now are crucial to your family’s future. Before leaping into the unknown, do your homework. Read up on the benefits of all of the types of life insurance and financial products you are considering.
Discuss your options with an insurance professional from an established company.
You can contact your state’s insurance commissioner for information on a company’s financial “health,” or check your local library for company ratings reports published annually by independent agencies such as A.M. Best. Study product illustrations carefully, and ask questions when necessary. You’ll want to fully understand the products that are proposed to you. If you’re uncomfortable with a scenario presented to you, get a second opinion: A financial advisor - professionally trained and experienced - like myself – can help you analyze your needs and recommend appropriate solution through insurance and financial products and concepts – at no charge to you.) When you have all the facts, then you can make an intelligent decision on what’s best for you and your family.
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