Term Life vs. Whole Life insurance – Rent, don’t buy
When it comes to life insurance, you have two main options – term or permanent (whole life, universal life). One is a relatively inexpensive way to protect your family from disaster, while the other is an expensive way to do the same thing coupled an inefficient way to invest.
Term Life is life covers an individual for a specific “term”. 20 and 30 year are the most common. If you die during the term, your beneficiaries receive a payout from the policy. If you outlive the term of the policy, the insurance ends, and so do the premiums. And you congratulate yourself for outliving your policy. We call this “renting” life insurance. Paying for insurance for the time period you need it, and letting it go when you don’t.
The cost of whole life insurance is significantly higher than term life for a few reasons.
1. It is designed to build cash value. That sounds like a good thing, and it can be, but there are better ways to build value. It is a “selling point”, but really, when you thought about getting life insurance, were you trying to protect your family from a sudden loss of income, or trying to build a retirement fund?
2. Commissions. Agent commissions are far higher for whole life and other permanent policies than they are for term life. Therefore, agents who sell them for a living might have some bias in recommendations. Take such recommendations with a grain of salt.
3. Whole life lasts your entire lifetime, as long as premiums are kept up. But since the insurance is permanent, you get far less for your dollar. And while it sounds good to have insurance your entire life, keep in mind that if you are doing the other things right (saving for retirement etc) that you shouldn’t NEED life insurance when you are 65+. This is what we consider “buying” life insurance. You own it for life, for better or worse. Insurance does not need to be permanent. The primary role of life insurance is income replacement, peace of mind that the family will be okay (financially) in the event of a loss of work income. And work income is not permanent. Most permanent policies are either cashed out when insurance isn’t really needed anymore (at unimpressive growth rates) or kept in place (and payments continuing) until death because the owner felt they had come this far, can’t give up now!
So, what should you do?
Our view is that for MOST people, life insurance should not be an investment. There are better and less expensive options for investments, with better projected (but not guaranteed) returns over long periods of time than Whole Life/Universal Life. Term insurance is very inexpensive in comparison and the old adage of buy term and invest the difference is tried and true. Buy the cheaper insurance, and add the difference in premium amounts to long-term growth assets with the goal to grow assets to such a point that life insurance wouldn’t even be necessary by the time the term ended. Spending as little as necessary on insurance and growing the rest is the best way to do this.
Just remember, when it comes to life insurance…rent, don’t buy.