Why Anything Other Than Term Insurance Is A Mistake

I recently had a heart-to-heart with my parents where I convinced them to cash in a whole life insurance policy that they bought for me when I was very young. They bought it for me when they were concerned that I wouldn’t live very long due to some poor health in my early childhood, but as an adult, I’m quite healthy. They’ve been paying the premiums every month since I was tiny and so now that I don’t need the insurance as badly as they could use the monthly premium amount and the cash-out value (which will pay off all of their outstanding debt and pay for their upcoming vacation).

Instead, I am covered by a thirty year term policy which cashes out to a very nice amount in the event of my death. The premiums each month are really small – I’m young, healthy, a non-smoker, and I only drink a couple glasses of wine a week (which is actually a health benefit, apparently) – and thus I just pay it for the peace of mind.

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At first, my parents thought this was reckless. They both have whole life policies for themselves and they wondered what I would do for life insurance when I got older. “Your term insurance will go away when you’re 58 and you’ll have nothing to show for it!” they shouted from the rooftops.

You know what? That’s just fine by me. And here’s why.

First, the monthly premiums on a term policy are substantially cheaper than a whole life policy. This is especially true at my age, where insurance companies are glad to offer me a term policy for a tiny premium: there is very little risk for them having to pay out by the time I’m 58. Statistically, I’m pretty close to money in the bank for them.

Second, the difference in premium prices can be invested. I pay about $60 less per month with my term policy than I would with an equivalent whole life policy ($500,000). If I invest that at an annual 10% return, I’ll have $137,003.40 when my term insurance expires. If I stop investing then and just let it build, on my 72nd birthday, the investment will exceed the value of the insurance. After that, it just goes on to the moon.

Third, my “excess premium” investment and my other investments will be enough to be my “insurance” in my dotage. I’m currently living a fairly frugal lifestyle that is enabling me to save and invest significant amounts of money each year. When I reach the age when my term life policy expires, I won’t need it. I’ll have more than enough money in my estate to pay for any expenses my family would incur in the event of my death, plus I’ll be able to leave a chunk of change to all of my children and grandchildren.

For me, whole life insurance is a poor deal; although it does build up some real value, the premiums are significantly higher and I have limited control over the investments – and the investment return. My feeling is that anyone under the age of forrty who is committed to a good financial life plan shouldn’t invest in whole life insurance, but that’s just one man’s opinion – don’t use it as the basis for your decision. Do your own homework.

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  1. Jon says:

    a number of years ago there was a company based on this whole idea it was called A.L.Williams. One of thier slogans was buy term invest the diference. I don’t know what happened to them.

  2. Nathania says:

    My dad’s life insurance ran out last year just as he was diagnosed with brain cancer. Obviously, he can’t get any more insurance. Could leave my mom in a tight spot if he dies. Thankfully, he now receives Social Security.

    maybe people don’t need a $500,000 whole life policy, but something to help out after a death would probably be a good idea.

  3. Trent Hamm Trent says:

    I’m planning for such an event now, Nathania, with 30 years of insurance to protect me until then. If I were 55 and didn’t have a solid investment base, I might feel differently, but I’m doing everything in my power to make sure that I do have a very strong financial base then.

  4. Mike says:

    Did you see the ad for “Simple Whole Life Insurance” on this page?

  5. Danielle says:

    Good point Mike. If you are so against whole life insurance then you shouldn’t have advertisers for whole life policies. That really makes you look like a hypocrite.

    By the way, I do believe you are right and if you are young with dependents then term life and investing the difference is the way to go.

  6. Trent Hamm Trent says:

    I’m confused as to how that’s hypocritical. Isn’t that honest? I’m basically saying that the people advertising on this page are selling a product that you don’t want to buy. That’s honesty, not hypocrisy.

    What would concern me is if I encouraged people to buy whole life insurance along with an ad for it.

  7. bmc says:

    THe problem is that most people DO NOT invest the difference.
    Perm insurance can be forced savings, depending on the company and the product.
    You can get get guaranteed perm product with an up-to 8 % return. THe money grows tax-free inside the policy and you can take it out without paying taxes.
    You could get a better rate of return with a perm product when the”cash value” is invested in mutual funds
    Is a perm. policy better that a term policy – that depends on your situation and what you are trying to achieve.

    Remember only 1% of Term Insurance pays out – People either convert it to permament insurance or the police will lapse – meaning that it goes past te 20 or 30 years and the premiums go so high that it is unaffordable. ( what is the point of paying into some policy for 30 years and then lapsing the policy – just throwing your money away – IMO.

    Remember you can get a permament product that you can pay into for a fixed number of years and you are done paying and have coverage for the rest of your life – say 10 years.

    Term insurnace, short for temporary insurance is just that. It is designed for temporary coverage.

    Manypeople have a combination of both

    Talk to a qualified insurnace instead fo trying to figure it our among yourselves.

    You dont hire a painter to do your plumbing?

  8. Trent Hamm Trent says:

    bmc is basically trying to advertise for whole life insurance, which is a notoriously poor investment. The purpose of term insurance is just that, insurance. It’s not supposed to be an investment; it’s supposed to be protection against a disaster.

    Remember, the worst thing you can do is go into an insurance salesman’s office without knowing what you want before you walk in the door. It’s the equivalent of going to a car dealership wanting a Ford Focus and having the salesman talk you into a SUV. Do your homework first, ladies and gentlemen, so salesmen don’t talk you into buying a product that doesn’t match your needs and wastes your money.

  9. Byron says:

    I sell life insurance and have been for almost a decade now. It’s very important to know just as BMC said, “You have to know what you want.”

    I aske clients whats the purpose of the insurance and the most standard response is, for life. You would be amazed of the people that get offended of a thought provoking question like this. First and foremost you and I are only investements to insurance companies; their actuaries know the number of people are particular ages are going to die each year. Now spread that over how ever many insurance companies there are(I broker for over 30); and thier niche market. Insurance companies are not paying out that much in life claims. Let’s teach our loved ones that the best insurance is to take care of yourself and protect the financial obligations and responsibilities with term insurance. Your lost income when you pass and the future of the lifestyle for your family. After children graduate and mortgage paid off and don’t use our homes as personal ATM machines; the need for insurance won’t be that great in retirement years that you planned for or supposed to have planned for. You would be surprised how many people in their late 60’s and 70’s still shopping for coverage. Insurance is not designed to leave your children well off either, its purpose is to be their for the what if something happens when the people that depend on me financially.

    Take care of your body teach your kids not to live above their means and purchasing insurance will be very easy.

    Email me if interested in Free Quotes for life insurance.

  10. ukmoneyblog says:

    Seems a term policy is a much smarter move.

  11. Ethan says:

    “what is the point of paying into some policy for 30 years and then lapsing the policy – just throwing your money away – IMO.”

    Why then do you pay for car insurance when you only get a payout if you get in an accident? The money isn’t being thrown away, because you do get a product– transfer of risk. That is a very real thing. That risk just isn’t there after a lifetime of good financial planning.

    “Remember you can get a permament[sic] product that you can pay into for a fixed number of years and you are done paying and have coverage for the rest of your life – say 10 years.”

    So you can have a capped coverage. I’d rather just be building investments that aren’t constrained by the policy face value. Besides, when a cash-value policy holder dies, the insurance company just keeps all of the cash-value balance and only pays out the face value of the policy. So you’ve built up 100k in your 500k policy? You’re family doesn’t get 600k. The cash-value is quite pointless. Pay in to your investments for a fixed number of years and then pile up 500k is value. You’ll also have coverage for life, and as THAT coverage grows, your family gets it all.

    Cash-value life insurance is just insurance plus investment/savings vehicle. I don’t see how getting an over-priced investment/savings vehicle is a good move. Buy the cheap insurance, and do the investing yourself. The return rates in cash-value insurance are abysmal. That is a lot to pay for a forced-savings plan. Set up automatic contributions to your mutual funds and get the same thing.

  12. Dean says:

    That’s great for you Trent, but I have a whole life insurance on me, set up by my parents. Back then, you don’t need much, but nowadays you do so that your family is covered. I have to know more about financial services since my grandfather passed away 2 years ago and now I’m sort of finding myself in the predicament that I should have known about this when i turned 18. I’ve started my roth, and my company gives me a 401k, but you know what, not too many people know the tax advantage of whole life insurance. Like I said, I have whole life policy started when I was 8, my father overfunded the policy, just enough so that it doesn’t look like investing. The face amount (death benefit) went up, but so did the cash value. I took a loan on that policy at a rate of 7.5%, which I DON’T have to back just as long as I keep paying the premium, which is still my money, to pay for my house. In case something should happen to me, my wife and kids still benefit minus my loan, still a good chunk of change, and everything is tax free. Whereas my other investments: CDs, stocks, 401, and even SSN are tax as income.

    So please Trent, do your research before putting the whole world into more debt.

    Who the hell cares about the commissions? Everybody needs to make money. Be it stockbrokers, real estate agents, car salesmen, Fry’s Electronics clerks, AVON lady, Body shop, tupperware, etc. Everybody needs to live, unfortunately we (the people) need money to live.

    What do you do for a living Trent? make people’s lives miserable by telling them wrong decisions?

    Not everybody is like you where “buy term, invest the difference” in what? over-taxed vehicles.

    Peace

  13. Margaret says:

    When my husband and I first got life insurance, we went to a financial planner who sold us whole life with an investment component. It was TERRIBLE advice. Now that I know about these things, I would never have done it that way. In Canada, you can invest through RRSPs — the contribution is deducted from your taxes, and you pay taxes on the amount when it is withdrawn, and all the growth is tax free. Well, we weren’t even close to maxing out our RRSPs — it made no sense to “invest” through whole life insurance (and the returns are not great), and our (ex) financial planner should have known this. Now that we have kids, we have gotten a term insurance policy. The payout is 5 times that of the whole life, and the premium is not quite $20 more (so it is less than 50% more expensive for 500% the coverage). I am tempted to cash out the whole life policy, but I think we have paid on it long enough that it now makes more sense to just pay it to the end. I’m not really sure how to figure that out, though. I suppose if one of us dies in the next 20 years, the other will be glad to have it. But if we live into our 70’s or 80’s, while it will be a nice little bonus for our then middle aged kids, it would not be necessary, and really, if you account for inflation, that $100,000 is only going to be like, what, $30,000?

    When we got our term insurance, we were given the option of choosing a 100 year term. The rate would have been higher, but then we could have had the insurance as long as we wanted — the rest of our lives if we so chose.

    For those who disagree with Trent — read the post — he makes it clear that it is his opinion. I happen to think he is absolutely correct and does a great job laying out the advantages of term life over whole life (especially if you are financially responsible and will have accumulated some wealth by the time your term runs out). One thing he doesn’t state is that in many situations, a family would need a much larger insurance policy than what they have, and it may be that the only way to affordably have that large of a policy is to buy it through term insurance.

    Good for you Trent in getting your parents to cash in that policy — very responsible and admirable that you are looking our for their financial interests as well.

  14. Gamalile says:

    85% of Americans live paycheck to paycheck. Roughly the same percentage of Americans do not have a family budget. Credit card companies tell us that over 50% of Americans have a balance of at least$5K. How many Americans smoke? Whole life insurance on automatic draft seems like the best idea for putting away dough since Bank of America started Keep the Change Savings. Whole Life policies speak to how we are living in the real world. Term policies are for a notable few because they actually invest the difference.

    But how many people that suggest term have that 10 years worth of difference in a whole life policy in the bank? Again, keep it real.

  15. Senior Guy says:

    Wonderful discussion.

    I agree with the premise of purchasing term and investing the difference in a “real” investment vehicle, like corporate bonds. Seems to me you can get a much higher return with minimal risk.

    Seniors who need insurance for estate planning purposes used to face an almost insurmountable hurdle; the sky high premiums. In today’s world, term is still expensive for them, but alternatives exist, including minimal cost premium financed insurance for life(not a STOLI).

    In addition, for those in need of income, there are immediate annuity programs where the senior receives income for life without any collateral or investment needed.

    What will the investment world think up next?

  16. Senior Guy says:

    By the way, the programs mentioned are offered by major life insurance carriers, and financed by Institutional Funders.

    It is all about the mortality arbitrage in today’s world.

  17. lc says:

    There are several major flaws in buy term and invest the difference:

    1. The older you are the more expensive life insurance becomes. Buy a 30 year term policy at the age of 30, when it expires at 60 IF you can quailify for a new policy the cost will be very high at a time of life when nearing retirement and expenses need to be curtailed.

    2. Cash Value Policies especially Universal Life are incredibly flexible. You get laid off work, fired from the job, become ill or injured…if you have cash in your policy you can suspend payments until you are “made whole”…i.e back to work. The premium will be taken from the cash value and since the “true cost” of insurance will be taken, which can result in the policy staying in place for a very long time. (Oh and for those who say it’ll never happen to me…stats tell us that one in 4 people will have a critical illness or injury that will result in them being out of work for a significant amount of time before age 60. 48% of all foreclosures and bankruptcies are due to illnees or injury.)

    3. If you need a loan (like me when I ended up owing the IRS $30,000), you can take it from the cash build up in the policy…you don’t have to pay it back and it comes very handy during a time of crisis. Since I had ready cash I was able to negotiate the IRS down and pay them off asap. My policy didn’t lapse and I didn’t have to pay the money back.

    4. Universal Life Policies have a guarantee minimium interest rate and they go up as the bank interest rates go up. The cash build up accumulates tax free and as long as the policy is borrowed against (i.e a loan is taken out) and the policy doesn’t lapes…the cash taken from the policy is cash free.

    5. Estate taxes unfortunately are not going away. If a person is leaving a considerable estate, over 3 million, a permanent policy is called for. The money will needed by the heirs to pay off the federal government.

    6. A widow or widower in the 70’s or 80’s or 90’s still have financial needs that will have to be meant upon the death of their love ones. Pensions, social security are seldom enough…especially if the death was due to a long illness. In some cases the pension isn’t available to the spouse nor is the full social security benefit available to the spouse. Money invested in the stock market can disappear quickly during an economic downturn.

    I find people who say buy term and invest the difference to be foolishly optimistic and short sighted on the facts of life. Life insurance is both a long term short and short term need. And often a combination of policies is the right soloution. However until the needs are analyzed by an insurance professional/financial planner (CFP) they should not take advice from individuals who are offering general statements. Especially when those individuals do not have the education or wide range of experience to properly guide the person.

    The advice for getting out of debt is close to that which I give in my life classes to young adults. Any advice on investments…I recommend seeing a Certified Financial Professional not a self help financial “guru”.

  18. Peter says:

    Okay, let’s consider some numbers.

    For a 25 year old woman, non-smoking, looking for $500,000 (ten times her salary), the state farm website says she’d pay about $30/mo for a 20 year term policy. For a whole life policy, she’d pay $303/mo. Assuming her take home after health insurance, retirement, etc. is $3000 per month, that’s 1% of take home for term coverage, and 10% for whole life. Lets say she invests just $250 of the difference (leaving $33 less than the whole life) assuming a 4% value over inflation in a *taxable* savings account, taking the numbers for 20 years until she’s 45 yields:

    20 year term: Premiums paid: $ 7200
    Investing diff $ 80678
    Death 19yr11mo15dys $ 580000

    Wholel Life: Premiums paid $ 72720
    Investing diff $ 0
    Death 19yr11mo15dys $ 500000

    My point is you’ve put ten times more into the whole life insurance, and per the last lines, if you die, you get none of it back. If you die halfway through, you get none of it back. If the whole life policy starts paying for itself half way through, you’re still getting none of it back if you die and you have still paid five times more into it.

    If, at the end of the 20 year term, you decide to invest in another $500K policy until 65, the premiums would be $840 annually for a 45 year old female. $80,000 at 4% above inflation a year yields $3200. So you can either take out $16000 and bank it to pay for the annual premiums (still less than what you’ve put into even half of the whole life policy), or just take it out of the interest you’re already earning. That or you could decide you don’t need as much and get a smaller policy or let the savings continue and pay out of your increased salary.

    Oh, and that $33 dollars I left out at the beginning, put $22 of that into the 20 year term ($52/mo) and double your protection to $1 million when you are very likely to need it, young kids, growing family, etc.

    Also, if you really need money in policy year 10 (at age 35), you’d have 35K or so, and it won’t be a loan you have to pay back at some rate for your own money. Or you can set it up to pay yourself back and get that fund back on track. Talk about flexibility.

    If you are out of work or injured, is it easier to pay $30 a month or $300? LC’s assumption is that you have enough cash value in the policy when injured that it will allow you to “carry” it for a time, typically until they run out of money in your “account”, then you lose it as well. However, even after year 1 with term, you’ll have $3000 in the bank and could carry the policy yourself for 100 months or over 8 yrs! (“But then they’ll use the money for other things”, sure but I’ll counter that if it gets that hard they’d cash in the whole life policy as well or it’ll collapse on itself because they can’t fund it if the tough times last too long).

    Let’s look forward to age 65. The term policy would lapse and the whole life is now certainly paying for itself and if you die at 66 it pays $500,000, in non-adjusted inflation dollars, or something like $153,000 in today’s value at 66 assuming 3% inflation. For the savings adjustment, assuming 7% (4% earning + 3% for inflation), you’d have $374K, or $115,000 as a rough inflation adjustment, or roughly 75% the value of the policy. However, if you just let the 115K grow at 4% for five years, it goes to 140K. While the life insurance pay out value, drops to $132K.

    Hmmm, so at 66 you now have a life insurance policy which pays out at 30% it’s original worth and will continue to decrease in payout the longer you live, which cost you at least 2 times more in premiums, and you could have around $115,000 in potentially increasing value in your pocket to do with as you please.

    Wow, I can see how that decreasing-in-value permanent life insurance policy could really protect an estate worth (in today’s dollars) over 3 million and let you pass gobs of money from that estate to your heirs. It’d be worth, what, around $98K if you died at 80.

    How about taking $100K from the savings at 66, putting that into paying for a great health insurance and long term care policy, then having a nice vacation with the other $15K before you’re too old to enjoy it. I think that would better address the fears of draining the bulk of the estate and leaving your widower or widow destitute due to long illness.

    And all of that was with a taxable account. If you put that $250/mo into a Roth, the numbers would only be bigger. And you could still take out what you put in, and still meet most of the other permanent life insurance advantages.

    So, to sum up. If you die while either policy is in force, you’re heirs get more money with term if you are saving and investing the difference. If you die in retirement, the longer you’ve lived, the more your savings become worth and the smaller the actual value of the permanent policy payout. Or you can use the money saved to buy additional insurance protection, be it health, long term car, or even life insurance. This would be especially benificial if you have had a separate retirement savings plan, which you would because where else would your 3 million dollar estate come from.

    Of course, all this depends on a person being able to save and actually invest the difference and keep that money separate from other life needs. I will also caveat this with the fact that there are some folks with family health histories which would make a permanent insurance policy attractive since they would be at serious risk going with either a 20 or 30 year term policy.

    However, the kind of person who feels that in 40-50 years they will have an estate large enough to need life insurance for protection, is very likely the same kind of person who can invest the difference and would not have much of a problem renewing a 20 year term policy.

    But then again, I’m just foolishly optimistic and short sighted about the facts of life.

  19. Prashant says:

    WRONG SUGGESTION…

    I am having whole life plan which keeps increasing sum assured every year with same premium rate, In case of term insurance this option is not available.

    Suppose, today value of my life is 15 lac’s then after 5 years it must be greater than that.

    Whole life plan which I am having right now gives me investment + insurance option along with Increase in amount of Sum assured every year.

    Do you know any term insurance plan working this way?

  20. Bill says:

    There is no “one size fits all” approach to insurance. Everyone’s situation is different.

    The one truth is that life insurance, whether it is term, universal, or whole life, is tax-efficient. The beneficiary receives the benefit tax-free. There is no other way to transfer wealth to a beneficiary with zero tax consequences.

    For my situation, buying term insurance was the best option. The investment portion of a whole life policy was way too conservative for my investment style. For me, buying term and investing the difference worked. However, in the next three years, my premiums will go up dramatically on the term insurance. I am in the process of evaluating different options.

    If my investments work out the way that I anticipate, I will need insurance for at least the next 10 years, but I may be able to reduce the insurance benefit. The value of the investments will make up the difference.

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