Term life insurance is less expensive than whole life insurance, as you may have heard. Numerous reasons that term life insurance is just a wiser financial choice are based on this precise assertion.
In order to put this claim to the test, we collected some information to better understand why term life insurance is so much less expensive than whole life insurance. This opinion is refuted by our research, so please continue on. Today is probably going to teach you something interesting.
Comparison Of The Premiums For Whole And Term Life Insurance
The initial cost of term life insurance is always cheaper than that of whole life insurance. Here is one instance. Think about a 35-year-old man in good health who wants to buy $1 million in life insurance. The cost of a full life insurance policy for this person will be $10,970 annually. This is supposing that the life insurance company will give him the best risk rating.
He pays $412 annually for the same $1 million death benefit on a 20-year level term policy. Once more, this is assuming that he is eligible for the best risk assessment.
It wasn’t a typo. No zero was omitted from the phrase premium by me. Actually, it costs $10,558 less than entire life insurance. I am aware of your thoughts. If that’s the case, who on earth would buy full life insurance.
Overview of the costs of term and whole life insurance
Term life insurance rates sometimes seem to be significantly less expensive than whole life insurance. Your money is greatly freed up as a result. We compared the alternatives available with whole life insurance versus term life insurance using a specific example of a male man wishing to buy $1 million in life insurance. Different beginning premiums apply. However, term life insurance has issues with longevity that might put you in financial trouble as you become older.
Additionally, as people age, their primary goals may change, which might work against term life insurance. There are certainly drawbacks to term life insurance, but it’s difficult to disagree that purchasing term and investing the difference results in a larger pot of money. In comparison to full life insurance, you could save more money. There is one term strategy you should avoid at all costs because whole life insurance will almost certainly be far more advantageous.
The End Of The 20 Year Term Policy
The $412 annual term insurance cost is for 20 years. At the end of the 20 years, the policy goes away. So to keep a death benefit, our now 55-year-old male, must buy another life insurance policy. Another term life insurance policy with a 20 year level period. This time, however, he won’t pay $412 per year. Now he’ll pay $1,643 per year. Again, this assumes that he qualifies still for the best risk assessment from the company. Twenty years from then, our individual is now 75, he’ll need to purchase life insurance again. The problem is he cannot. Presently life insurers will not issue a 20-year level term policy on a 75-year-old.
So let’s not worry about life after 75 for the moment. Let’s focus on how things have gone up to that point. If our individual bought term life insurance and then rebought term life insurance at 55, he spent $61,102 in life insurance premiums up to this point. If he bought whole life insurance, he paid $438,800 in insurance premiums. This isn’t looking all that great for whole life insurance. Except that he’d also have $1,335,392 in cash value inside that whole life policy and a total death benefit of $2,213,635. That’s a considerably higher death benefit than the initial $1 million.
Legacy Matters To People
Our career in the insurance industry spans several decades. When you get this point, you experience a lot of different interactions and gain understanding about what drives people that aren’t always obvious at 22. For a lot of older and more experienced people, their worry is more about legacy. We see from above that buy term and invest the difference bests purchase whole life insurance in terms of projected cash value by almost $310,000. That’s a lot of money.
But we forget that at this point the term life insurance goes away. So our individual carries on with his $1.6 million and no life insurance. Many might point out that with $1.6 million, he’ll probably be just fine. But if he owned whole life insurance instead, he’d have over $2.2 million in death benefit. If this mimics the behavior we see among people in their 70’s and older, his concern about legacy becomes important. I’m not saying everyone thinks like this. There was a time I thought no one thought like this. Each year, I learn the number of people who do think like this is substantially larger than I ever imagined. I also find that as I get older, I think about it; I’m nowhere near 75. So while buying term and investing the difference might produce $310,000 more cash for our hypothetical client, it sacrifices $568,612 in cash, the client could leave behind.
Purchase a term and invest the difference.
In our case, the whole life policy’s cash value at age 75 is $1.3 million. However, proponents of the term will argue that since you have $10,558 left over (for the first 20 years), you may invest the difference. That would likely result in you earning more money than the full life insurance coverage.
So, in order to assess how things stand up, we ran the figures. We’ll suppose that our 35-year-old will invest the whole amount of the premium difference between term and whole life. The first 20 years are worth $10,558. Then, let’s imagine that he has had $9,327 to invest annually for the past 20 years. This accounts for his having to buy a new term policy at 55, which is more expensive. We’ll assume the return, net of fees, taxes, and adjustments he’ll need to make as he gets older and wants to take on less risk, is 6.5% per year for the entire 40 year period.
Doing this, we see that the invest the difference strategy should produce an account balance of $1,645,023. This isn’t looking so good for whole life insurance. It’s at this point; most term life only advocates declare victory. But before we call this one, we want to explore some additional considerations.
A Life Insurance Argument Built On Assumptions
Buy term and invest the difference works out better provided a lengthy number of assumptions work out as planned.
- You actually invest the difference. This one causes a lot of problems from the get-go.
- You can actually continue to buy term life insurance. In our example above, the client maintained his excellent health through his 50’s and qualified for the best rates as a result. If the underwriting assessment at 55 finds his health average, his premium for term life insurance increases from $1,643 to $5,144.
- You actually achieve the rate of return assumed. 6.5% might appear small against some of the numbers other investment gurus talk about, but I’m talking net return. Also, remember that this is about 2% higher than the average gross return achieved by stock market investors according to DALBAR research.
- You NEVER touch any of this money until age 75 for any reason whatsoever. Selling off investments because you need the money can hurt your overall return, especially if you have to sell when the market is crashing. Unfortunately, rises in unemployment and market crashes tend to happen around the same time.
From really healthy to average
If our customer is in ordinary health at age 55, as I said in the previous section, his term life insurance premiums will be significantly higher. precisely 213% more. Remember that this does not imply that he has a serious medical condition. Just that he’s older and in better physical condition. As life progresses, occupations get more demanding, children are born, and you just have more weight to lose, these stressors may make you slightly less likely to participate in frequent exercises.
Lots of people go through a second growth spurt, only this time it’s horizontal. With each year that ticks by, you have yet one more chance for something to come along making you no longer the super healthy super low insurance risk you once were. If we go back and plug the buy term and invest the difference numbers in assuming that our client is just standard health at 55, our results change a good bit.
Now he only has $5,826 to invest after paying term life insurance premiums for the second 20-year stretch. This results in a much lower accumulated $1,438,905. Still higher than the whole life policy, but now only around $100,000 higher. This also means sacrificing even more value on the legacy side, $774,730 to be exact.
Term Life Insurance You Can Keep
At one time, you could buy term life insurance with a level premium for a specified period and keep the policy after this level period. You had to pay an ever-increasing premium in order to keep the policy, but so long as you paid this increasing premium, you could keep the death benefit. The rules on this changed quite a bit over the past few years. Now few life insurers offer term life insurance that you can keep. Instead, the policy simply ends at the end of the level premium period.
But, some life insurers still offer term life insurance that you can keep provided you pay the increased premium. So, why not just buy this type of term life insurance. Since you qualify for great rates now, wouldn’t it benefit you to continue to pay the increasing premiums as a preferred risk rather than potentially at some lesser in the future? Makes sense, but unfortunately, it doesn’t work. Going back to our original example, a term life policy that allows the policyholder to continue paying increased premiums after the 20 year level period will cost $423 per year — a very modest increase over the original term life policy.
But after paying all the increases in premiums in years 21 through 40, our client will pay $827,010 in premiums. That’s $388,210 more than the whole life policy premiums over the same period. Forget invest the difference. He’ll run out of money due to the premium increases.
Is Term Life Insurance Cheaper Than Whole Life Insurance?
If you don’t consider the alternatives that whole life insurance offers, term life insurance will just be less expensive than whole life insurance. Term triumphs in the strict sense of what it cost you today, disregarding what it will cost you later. Buy term and invest the difference could be effective in the absolute sense of how much money you can spend on yourself right now, provided a lot of assumptions go in your favor.
There are several factors to take into account with whole life insurance. Anyone who makes this claim is attempting to sell you whole life insurance just as hard (if not harder) as they are.