Buy Term Insurance and Invest the Difference?
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Is term
insurance the best way to buy life insurance?
Your choice
of life insurance depends on how much coverage you need, how much premium
you can afford and whether you want life insurance only for its death benefit
or also for its savings potential.
In recent years
a new concept has become more popular - rather  than
choosing a whole life insurance policy, you purchase a lower cost term
insurance plan and invest the difference, usually in mutual
funds or investment-linked fund. This approach
may be well suited for some people, but for others it may not make sound
financial sense. Such an important decision, however, should be undertaken
only after a complete analysis with a financial planning consultant of
the potential results that includes a consideration of taxes and possible
down markets.
Term Insurance
Term insurance
pays off only if you die; whole life and investment linked insurance combines
a death benefit with cash value and an investment fund. For short-term
protection, from one to 15 years, term insurance could be suitable. It
will give you the most protection for the least money. Term coverage starts
with low premiums, which are either adjusted annually or can be locked
in for periods of 10, 15 or 20 years. The longer the lock, the higher the
premium.
Whole Life Insurance
Whole life insurance,
by contrast, lets you lock in one premium rate for your lifetime. Part
of your premiums are invested and build up a cash reserve with tax-deferred
earnings you can draw from. However, whole life insurance premiums are
much higher than term premiums.
Why Term Life is Better for Most
People
Simplicity
Planning financial goals around a
whole life insurance plan can get really complicated. There are non-trivial
rules governing things like the size of your cash value savings versus
the policy death benefit, and the repayment of policy loans. Term life,
on the other hand, is the essence of simplicity - pay the premium, get
covered for the term.
Competitive pricing
Because they are so simple, term
life policies can be easily compared on the basis of price. This has led
to a very competitive market in which term life policies are rapidly becoming
a commodity.
Flexibility
Many term life policies are both
"renewable" and "convertible." The former ensures that you can renew for
another term policy without a medical exam. The latter allows you to convert
your term life policy into an equivalent whole life policy from the same
carrier, should this make sense during the term of the policy.
Not all term life policies offer
these features, however, so be sure to ask for them specifically if you
want them. (In particular, be sure you know what they mean by "renewable.")
On the other hand, whole life policies
only work out well when they are held for life. Once you're in, it's tough
to get out without a little financial pain.
Some Reasons to Consider Whole
Life Insurance
Insufficient retirement savings
Most of the insurance planning computations
assume that you have a separate plan for retirement savings. If this is
not the case, and you expect to continue working through your golden years,
to make ends meet, you may want to consider a whole life policy. Term insurance
in retirement years will be extremely expensive, and may not be available
at all. In this case, whole life insurance may be the only way to provide
your spouse with sufficient replacement income, should you die first.
You're older and not in great
health
Term life insurance gets more expensive
as we age. It's cheap while we're young, prohibitively expensive when we
get up to age 50 or so (for the same face value). As we age, though, face
value could decline as our needs drop, so premiums could be held relatively
constant in real terms.
Forced savings
By moving some savings contributions
into a bill that must be paid - your premium payment - whole life plans
do promote savings discipline. However, automatic payroll deductions into
a retirement account can serve the same purpose. Also, funds can be automatically
and regularly transferred from your bank to your brokerage account or investment-linked
funds or mutual funds. Compared to these options, a whole life policy can
be a relatively expensive way to feed your piggy bank.
Don't Make Mistake, But Make
Informed Decision
Although buying
term life and invest the difference could benefit most people, such decision
should be undertaken only after a careful and complete analysis with a
financial
planning consultant of the potential results. |
