There’s a popular philosophy that you may have heard of. It’s called “Buy Term And Invest The Difference” and there are many financial professionals who promote it. On the other side of the coin, there’s a philosophy of buying permanent life insurance that will build cash value. Which philosophy is better? Which strategy is best for you?
It’s going to depend on several factors. We’re going to go over the life insurance advantages and disadvantages of buying term and investing the difference vs buying permanent life insurance.
Buy Term And Invest The Difference
What does is really mean when financial experts like Dave Ramsey and Suze Orman recommend that consumers should buy term ad invest the difference? What are the life insurance advantages and disadvantages when you invest instead of getting a whole life policy?
Buying term life insurance and investing the difference simply refers to this:
- Calculating how much money it would cost you if you bought a permanent life insurance policy as well as the cash value growth that the policy will provide in the future.
- Comparing it with how much a term life policy would cost and investing the difference.
Here’s a quick example: A 30 year old male is purchasing a $100,000 life insurance policy. Here are his monthly premium choices:
- 30-year Term Life: $12 per month
- Whole Life Policy: $90 per month
The term life policy has a difference of $78 compared to the whole life policy monthly premium. Now if you were to take the $78 and invest it, would it be a better solution to your financial goals -or- is simply paying for a permanent life insurance policy and letting the cash value grow a better option? It depends.
Let’s look at the 2 most common spending, saving and investing behaviors that people typically exhibit.
Rent the term, lapse it and spend the difference
When it comes to most people, they buy inexpensive term life and plan to invest the difference — but they don’t. David F. Babbel, co-author of “Buy Term and Invest the Difference Revisited” & a professor at the Wharton School of the University of Pennsylvania.
Mr Babbel stated, “People don’t buy term and invest the difference; They most likely rent the term, lapse it and spend the difference” he explained in Journal of Financial Service Professionals 2015 May issue.
Will you invest the difference?
It’s extremely important to be honest with yourself and understand your spending habits and behaviors. Have you always been disciplined with your bills, debts, and spending habits?
Are you the type that would want to use the extra money that a cheap term life policy provides — and spend it elsewhere? Then a permanent policy may actually be a better fit because you’ll simply pay your premium and be done. However, if you’re disciplined and you consistently invest the money left over with the proper investments — then buying term and investing the difference might be for you.
Why Life Insurance is NOT an Investment
Life insurance is not designed to be an investment. First and foremost, it is meant to provide your family financial protection if you were to die pay a death benefit to your named beneficiary. Using a permanent life insurance policy as your ‘go to’ investment vehicle isn’t wise.
Life Insurance Fees
One of the biggest reasons that a permanent life insurance policy is not a good investment is that it has a lot of fees. These fees put a damper on your returns. Your permanent policy builds cash value slowly, but would grow quicker if it didn’t have all of these fees.
Fees that could be included in the policy include commissions, surrender charges, and annual investment fees. The end result? If you don’t hold on to your permanent policy for the long haul, you’re at risk of not getting a good return.
Patience
Another reason why permanent life insurance isn’t a good investment is that you’re going to have to wait many years before your get access to your cash. What’s the reason for the long wait? — the policy takes a long time to grow its cash values.
You need to understand that the fees you pay on your policy are loaded on the front end. This means in the 1st few years, your policy’s premiums are paying for the life insurance company’s administrative fees, agent commissions, etc. — before they begin to grow significant cash value.
When does permanent life insurance makes sense?
Is permanent life insurance a bad product? Definitely not! Permanent life insurance has its place and it provides solutions for several situations.
- For wealthy and high net worth people searching for a means to reduce estate taxes.
- For individuals that already have a diverse investment portfolio, maxed out their tax deferred options and looking to add another tax advantaged investment.
- For people shopping for lifetime coverage instead of temporary coverage.
Bottom Line
It’s usually a pretty bad deal when hen looking at permanent life insurance policies as a pure “investment” vehicle. When it comes to investing, it’s usually a good idea to be laser focused. Don’t try to use 1 product to do multiple things. Life insurance is a great product that serves a specific purpose.
If the purpose of your policy is for estate planning, reducing estate taxes or when you’ve maxed out other tax deferred options — then a permanent policy may be the right choice. For most other situations, a term life policy will be a better choice.
