If you're wondering "Would buying term life insurance instead of buying more expensive permanent insurance, then invest the difference be a better investment?" Listen to Byron as he runs the numbers for you.
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I think it’s important to clearly define what we’re actually comparing. Let’s start with Term. TERM life insurance, by definition, is temporary insurance. It’s typically sold as 10, 15, 20, 25, or 30 year level terms, meaning that, for instance, a 10-year term has ten years of level premiums, before the rate jumps dramatically in year 11 and goes up from there. 20-year terms have 20 years of level premiums, and so on.
With level term, when the term period expires, the rate jumps so much (sometimes, to as much as 10-20 times the level premium you HAD been paying) that most people simply cancel their policy. Now that begs the question: "What do you do at that point if you still need or want to maintain the coverage?"
If your health is good, you may be able to buy another term policy, but if your health isn’t good, you may not. As we get older, we typically don’t get healthier. So there’s obviously no guarantee that a new term plan will even be available for you down the road when you reach the end of a level term plan’s level term.
Permanent life insurance, unlike term, is NOT temporary coverage. It's designed to last a lifetime. It certainly costs more. The premiums are usually designed to remain level for your entire life, and if it’s done right, and you pay your premiums each year, it’ll remain in force until you die…assuring that your family will receive the death benefit!
Now, here’s the biggest secret of the life insurance industry. If you want to win the game of life insurance. Pay close attention to the following six words:
DIE WITH YOUR POLICY IN FORCE.
So assuming you die when you’re supposed to, around your life expectancy, in order to have your life insurance in force, you have to own a policy that cannot be canceled by the insurance company before you die, won’t EXPIRE before you die, and that has a predictable, affordable, level premium that can never be raised by the insurance company in order to force you out before you die.
So getting back to whether it makes sense to buy TERM and invest the difference…let’s do the math. The numbers will tell the story.
For our comparison, let’s use two of the most popular product categories…20-year term and Guaranteed No-lapse Universal Life
Our example assumes a 45-year old male in excellent health, with a life expectancy of around 86, or 41 more years. The cost for a 20-year term life policy with a $500,000 death benefit is $600 a year. Universal Life with a lifetime guaranteed level premium, same death benefit costs $3,700 a year. If we invest that difference at say 4% after tax (which is equivalent to earning about a 6-7 percent pre-tax return. At the end of 20 years, the value of that side fund would be $96,000. Then what? You’re now 65 and probably not independently wealthy.
If you had the term insurance, and that side fund of $96,000, you might think well, let’s just get another 20-year term. To replace that $500,000 of coverage with a new 20-year term, would cost you about $14,000 annually. Of course, your $96,000 side fund would cover the cost of the first 7 years of that policy, but then you’re back to having to pay out of pocket...$14,000 a year. And even so, that policy will last exactly another 20 years, bringing you to age 85.
Now, let’s say you live to age 86, your coverage will have expired at age 85. And trust me, if you try to replace it at that age, you’ll be so shocked at the price you might have a stroke right then and there. Forget about it. You’re gonna die without life insurance. No one will get the $500,000. And you will have paid $600 a year for the first 20 years (that’s 12,000), plus $14,000 a year for the next 20 years...that’s $280,000 (for a total of $292,000) for 40 years of term insurance. So you end up collecting nothing.
Now on the other hand, on Day One, if you had bought a Permanent Universal Life policy, with the guaranteed premium of just $3,700 a year (through age 85), you would have paid just $148,000 (plus another $3,700 for age 86), you’d be all in for $151,700. Then…you die. But your spouse, or children, or grandchildren collect $500,000...Income Tax-Free!
There’s no question that term insurance serves a valuable purpose and solves the problem temporarily…but not permanently. And there’s a good reason that term insurance policies are cheap. Statistically, only 1.5% of them actually end up paying a death benefit because they lapse or expire before you die.