Whole Vs. Term Life Insurance: Is Buy Term and Invest the Difference the Best Investment Option?

Written by Rob Pinner

Life insurance is a financial instrument with the purpose of providing benefits to beneficiaries/dependents if the insured meets an untimely death or due to ailment. There are two types of life insurance – term and whole life. These two are differentiated with their maturity and other privileges/inclusive their policies carry. Term insurance is straightforward life insurance with a maturity date set to certain period, from 5 to 30 years. Whole life insurance is set for life or until the insured is alive with additional income option called cash value. Cash value is the investment option within the policy that allows the insured to set aside savings from the premium paid after deducting the insurance – death benefit aspect of the policy. “Buy term and invest the difference” is rooted to the principle that by getting a cheaper policy and invest the savings from buying term as compared to getting a whole life that’s more expensive maximizes your savings and earning potential.

The slogan of buy term and invest the difference is recommended by some financial advisor who believe that the investment through other means such as 401K, stocks or bonds may perform better than investing in a whole life with cash value.

Let’s begin in examining these types of policies of through their definitions and characteristics:

  • Whole life insurance also known as Cash Value life insurance is a type of insurance with premiums with two building blocks, insurance and investment. The premium paid goes to these two building blocks. The insurance element pays for a pre-established sum for death benefits while the investment element establishes an accrued cash value the policyholder can withdraw or borrow. Whole life is permanent, lasting throughout the insured individual’s entire life.
  • Term life insurance is the cheapest type of life insurance that provides death benefits at a fixed premium for a period or term. They are available in 5-year increase with terms not lower than 10-year to 30-year terms. Buying term at the earliest possible time and getting a very optimal premium that affords you more savings insurance payments gives you the option of investing the rest of the savings to diverse investment modes including 401k and stocks.

Whole Life Vs. Term Insurance

By maximizing investment potential whether through whole life or term insurance, you are setting up funds to protect your family as well as for your retirement. So how does a person choose between whole life and term insurance with regards to retirement financial security and tax-free cash flow? Let’s compare the advantages and disadvantages of each type of policies.

Whole Life Insurance Advantages:

  • Adjustable premium payments
  • Cash value that’s subject to loan options and withdrawals
  • Permanent life insurance equals getting death benefits lasting through one’s lifetime.
  • Optional fixed rate
  • Helps maintain savings and income opportunities upon retirement
  • Provides better option in terms of investment with better rate of return than the traditional low risks options such as bonds.
  • Tax-free cash withdrawals from cash value.

Whole Life Insurance Disadvantages:

  • Cash value is different from the death benefit. It is not included in the death benefit.
  • Withdrawing money from accumulated cash value fundamentally means taking out a loan that must be paid back with interest and a surrender fee.
  • Experiencing a downturn of the market may affect the interest rate of the cash value down to zero, this could result to paying the premiums out of pocket and if the policyholder can’t follow through, the policy can be cancelled.

Bottom line consider the advantages and disadvantages of the whole life policy as well as projected income before signing the dotted line. The level of commitment and income projection are also important because this is permanent and lifelong. On-time payment of premiums is crucial to get the most out of the cash value and death benefit.

Term Life Insurance Benefits:

  • Term insurance gives the same coverage as whole life in terms of death benefits.
  • Affordable premiums
  • Fixed rate for a certain period
  • No surrender charges
  • No startup costs or hidden fees
  • Flexibility on changing the policy at any period or to cancel without the worries of surrender charges.

Term Life Insurance Drawbacks:

  • No benefit upon maturity. If the policyholder outlives the insurance period, there are no benefits to be claimed against the premium paid. In some cases, if the policy guarantees a maturity benefit, it will be less than the accumulated premiums paid during the insured period.
  • The motivation to pay the premium may dwindle down upon reaching a certain period. Motivation to pay dwindles because outliving the maturity date does not guarantee any benefits or getting back the premiums paid.
  • No flexibility because the contract is straightforward death benefits only.

Affordability and coverage for a certain period are the best benefits of Term insurance. It provides financial stability for the family against untimely death to cover for major debts such as mortgages and large loans as well as income leverage.

Buying term and invest the difference allows an individual to be covered as well as have savings leftover that can be utilized for other investments such as stocks, bonds or real estate. This is a great way to spread an investment portfolio, with coverage in case of untimely death to pay for large loans, and for investment purpose to be utilized as passive or retirement income.

The problem with buying term life insurance and investing the difference is getting around the investment part. A lot of people get the cheap term insurance then don’t get to establish their monthly investment account. Protection from untimely death, check! And investment portfolio that increases in value over a period; used as passive income in the future, none! A whole life insurance contract addresses this issue. You are obligated to put the “savings” or “difference in the whole life premium directed to cash value account that earns interest with the option of fixed or indexed to a market rate.

There is the risk that future savings earmarked for premium payments fluctuate due to career changes or other personal financial issues. There are many flexible whole life or permanent insurance that suits these types of financial situations. One strategy of whole life insurance is once the cash value amount accumulates over the years; this can help in premium payments to the extent of not paying out of pocket and using cash value to keep the policy.

Last Words on Whole Life Vs. Term Insurance

Both these types of insurance products are good depending on the financial situation, projections and objectives of an individual being insured as well as the future financial objectives of the family. Whole life helps maintain the flow of saving into a nest egg without having to rely on other investment portfolios. Term life on the other hand, helps in keeping coverage at the lowest possible cost with a lot of leftover savings to invest in other means including college funds, real estate, stocks and bonds.

The key is to study and understand each type and what they can bring to the table and consider which best suit current and future financial standing. Getting a term policy can be a better option especially if you already have an investment portfolio and the only thing lacking is the insurance component.

Rob Pinner
Rob Pinner

I have been a licensed insurance agent for over 15 years.  If you have any questions or comments please don’t hesitate to give us a call.

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