Term or Whole Life Insurance?

on September 6, 2019

Have you ever heard the financial phrase, “Buy term and invest the difference?” It’s a common saying, and sometimes, it’s great advice. However, like all financial issues, the decision is a little more complicated than it might look.

Let’s start by reviewing the advice. The recommendation is to purchase term life insurance rather than whole life. Term policies are typically cheaper, so the money saved in premiums could be invested. The growth of this money is supposed to provide income after the term policy expires. Remember that term is temporary, while whole life is permanent. But is the advice sound?

First, the CERTIFIED FINANCIAL PLANNERTM Board of Standards says the purpose of life insurance is to manage the financial risk associated with your death. As a result, the primary purpose of insurance would not be as an investment or savings vehicle.

When you are trying to decide on the type and amount of insurance, I think it’s difficult unless you take a cash flow perspective. How much money do your heirs need, and how many years does the need exist? Looking at their income requirements during different periods of their lives is a great way to start.

If their financial risk has a definite end (like a mortgage), term might make sense, but if the risk is ongoing, then whole life might be preferable. If you are considering term, it’s important to look at the difference between whole life and term premiums. If you invest this sum of money at a reasonable rate of return, does that sum provide enough cash to meet any needs when the term ends? If it does, then the strategy might work for you and them. However, remember you must adequately calculate their needs and not assume a rate of return higher than the one they actually earn. Additionally, by the time your term policy expires, you may not qualify to purchase a whole life policy, so be careful as you make your calculations.

Finally, the biggest risk to buying term and investing the difference is that you really have to invest it! Too often, the money just disappears into your bank account. This error can lead to catastrophe if you die after the term policy has expired and you haven’t made additional plans. But with a little thought now on the part of you and your financial team, you can help ensure your heirs will have the resources they need, even if they can’t replace you!

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