Term Insurance vs. Permanent Insurance?

Term Insurance vs. Whole-Life

What is the difference? Well, the way I like to put it is term insurance is similar to renting an apartment, while whole-life is similar to owning a home. While term (like renting an apartment) is cheaper, no equity is ever built up. The policy owner will have to pay premiums, similar to rent, and will never see those dollars again. Whole-Life on the other hand (like owning a home) is more expensive, but equity is built up over time and the policy becomes valuable. So if we take a look at it from a 10,000 ft level, it is a great long term investment if it can be afforded; I put an emphasis on the “if it can be afforded” part. A lot of times owning your home or insurance is predicated on the matter of your budget and what you can afford, as well as liquidity. A key question to ask is when will this money be needed? Obviously if the money is needed in the short-term i.e. within 10 years, there are probably a lot of better places you could put your money.  But if the money isn’t needed for quite some time and you do need life insurance Whole-Life is very appealing.

Some people, including the self-proclaimed guru Suzie Orman, will say you should buy term insurance and invest the difference. Their thought is that by investing your money elsewhere you can earn a higher rate of return. They are only partially correct…they are correct in saying historically you can earn a higher rate of return utilizing other vehicles, but the point they are missing is that they aren’t investing the full amount, but rather only the “difference”. For example: 500,000 of term insurance for a 30 year old male might cost around $300/year. Whole-Life on the other might cost around $5,300. So the investor by “renting” their insurance would be able to pocket $5,000 and invest that wherever they’d like. So right away they are already losing $300 off the top of your investment each and every year which these whole-life critics seem to forget. In order to overcome that $300 deficit they need to outperform the whole-life returns by an extraordinary amount. Please take a look at the excel spreadsheet below that I created utilizing a 30 year old male in good health. You’ll notice by buying term and investing the difference you’ll actually be more profitable within the first 12 years. Every year after that you’ll have to earn SIGNIFICANTLY HIGHER returns. (I ran all outside investment returns at 7% which is pretty high considering the S&P in the last 20 years certainly has not obtained those returns)

After 20 years you’ll notice the life insurance policy returned 3.42% while the outside investment would have given negative returns despite earning 7% a year. (This is because term insurance becomes more expensive as you age while whole-life remains level) A note on time-horizon: please notice that it takes 12 years to start turning a profit via the life insurance. Also none of this takes into account taxes. Life Insurance in most cases can be tax-free dollars. (Put a 15% tax on your capital gains in the outside portfolio and these numbers would change even more!) One last note, life insurance can also be overfunded like how a mortgage can be paid down quicker…typically this simply means more cash would go to the internal portfolio, boosting those returns.

In essence: buy term and invest the difference is horrible advice if you need the insurance (take that Susie Orman I have the numbers), but if you don’t need the insurance and think you can perform better than 3% by all means invest in other vehicles!

				Outside	Whole Life
Year	ACL	Term	Difference	Portfolio	Cash Value	Result	CIR	IRR
1	5414	268	5146	$5,506	$202	($5,304)	1.70%	-96.27%
2	5414	268	5146	$11,012	$4,316	($6,696)	3.41%	-72.63%
3	5414	268	5146	$16,519	$8,683	($7,836)	1.69%	-57.60%
4	5414	268	5146	$22,025	$13,337	($8,688)	1.13%	-31.82%
5	5414	269	5145	$27,530	$18,277	($9,253)	0.84%	-19.78%
6	5414	269	5145	$33,035	$23,565	($9,470)	0.67%	-13.04%
7	5414	275	5139	$38,534	$29,267	($9,267)	0.55%	-8.77%
8	5414	287	5127	$44,020	$35,408	($8,612)	0.46%	-5.85%
9	5414	303	5111	$49,489	$42,017	($7,472)	0.39%	-3.75%
10	5414	316	5098	$54,943	$49,114	($5,829)	0.33%	-2.19%
11	5414	334	5080	$60,379	$56,743	($3,636)	0.27%	-0.97%
12	5414	361	5053	$65,786	$64,893	($893)	0.23%	-0.02%
13	5414	386	5028	$71,166	$73,588	$2,422	0.18%	0.74%
14	5414	420	4994	$76,509	$82,863	$6,354	0.14%	1.36%
15	5414	460	4954	$81,810	$92,745	$10,935	0.11%	1.87%
16	5414	505	4909	$87,063	$103,250	$16,187	0.07%	2.29%
17	5414	551	4863	$92,266	$114,420	$22,154	0.03%	2.65%
18	5414	592	4822	$97,426	$126,236	$28,810	0.00%	2.95%
19	5414	634	4780	$102,540	$138,701	$36,161	-0.04%	3.21%
20	5414	675	4739	$107,611	$151,832	$44,221	-0.07%	3.42%
	ROR
	1.07