There is a common argument out there amongst the masses when it comes to your life insurance needs… should I buy whole life insurance or should I buy term?
Well it’s important to understand that this is a very valid argument, however, some people have an almost crusade mentality when it comes to insurance, either on one side or the other.
So, let’s take a step back and look at both of these insurance products, what they have to offer, and what they lack.
First lets start with term life insurance.
Term insurance began being heavily promoted back in the 1970’s with a man named A.L. Williams. His father died of a heart attack and was underinsured. Williams began promoting term insurance heavily and became a billionaire from it. His company eventually evolved into what is known today as Primerica.
Now, the reason why term insurance is such a great product, and the reason why A.L. Williams was so heavily promoting it, is that it provides a cheaper alternative to its counter part, whole life. With term insurance you can get heavy insurance coverage for a very low price.
Why is that? Well to the insurance companies, it’s because term insurance doesn’t often pay out in a death claim. About 1 percent of term life insurance policies pay out in a death claim.
Term provides the necessary protection for the individual, and a nice chunk of change for the insurance company because it is generally low risk.
Whole life insurance for long life
Historically, when companies offered pensions and retirement plans, having a term-only strategy made sense.
However, the problems we face in America today are much different than they used to be. Many companies no longer offer pensions plans to their average employees and many individual retirement investments are now placed in volatile markets. As a result, people are in debt and working much longer in life.
What does this mean? It means that by the time term-life insurance is becoming too expensive to afford (60+), people are still working and still have debts. Not to mention the fact that expense of death is ever increasing.
Although term life insurance offers a low cost, it is still a cost of insurance that provides no living benefits to the insured, only a death benefit if the insured were to pass away during the years of the term.
On top of this, the mentality often is buy term and invest in mutual funds, but has that strategy really worked? A study by Dalbar, a mutual fund research firm, shows us that the 20-year average for mutual funds is 3.8 percent. This means that people are putting all that money at risk for meager returns.
So term can offer us some very good benefits, but can be a lot like renting a house. Now let’s look at the counterpart, whole life.
Whole life insurance has received an extremely bad reputation since the A.L. William’s days, however, does it deserve such a bad reputation?
The problem with whole life insurance is that it can be much more costly for the coverage, compared to term.
However, whole life insurance has some characteristics you may not be aware of. Let’s take a look at a few of these.
Use of money – Whole life insurance not only provides a death benefit, but it also provides a cash value account that can be used as collateral to take loans out from the life insurance company. This means that not all of our money is tied up in the actual insurance, and we have access to money if we need it.
Many famous companies were started with such whole life insurance policies; Disneyland, JC Penny, McDonalds, and Stanford University to name a few.
Cash accumulation – In the past, it could take 15 or more years to have the dollar you contributed available for you to use. There are many factors that played into this, and without an understanding of dividends and differences in life insurance companies, many people didn’t see the benefits quick enough, and were easily persuaded into the buy-term-and-invest the difference philosophy.
However, if we use a properly structured policy with a participating insurance company, we can recover our contributed dollars in 6-8 years.
Growth potential for your money – Unlike term insurance, whole life is basically an investment. Looking at an actual example, if we would have had our money in a 10-pay Mass Mutual life insurance policy from 1981 to 2008, we would have had a 28-year internal rate of return of 6.5%.
Costs don’t change – The real difference between term and whole life is that whole life is just that, it will be around for your entire lifetime. So, as long as you keep it in force, you are guaranteeing to transfer a substantial chunk of money to your heirs to pay off debts, and as an inheritance. And the risk is on the shoulders of the insurance company, so you protect yourself from a premature death as well as planning for your passing after a full healthy lifespan.
And, every year as you accumulate more cash value, your costs compared to your dollar get smaller. Making whole life policies more efficient every year.
No taxes – The last benefit I want to mention is that the rate of return, as long as the account stays open, is a tax-free growth called a dividend. And when you die, your death benefit will transfer to your heirs tax-free. This is what makes life insurance such a strong candidate for not only benefits while living, but also at death.
What’s the best approach?
So now, what’s the best strategy when it comes to life insurance? My answer to that is – have both. Plan to put some of your retirement savings dollars into a structured whole life insurance policy, let it build over time until it is producing more insurance than you need. Then phase out the term.
This way, not only are you going to have insurance in the whole life policy, but you will also have access to capital if you need to make purchases, or you need it for a rainy day. Now you will have a life insurance structure that also provides you with steady rate of return, as well as moving your death risk to the insurance company.
In the mean time, get some cheap term insurance to cover you now, until you have built up enough in your whole life policies to get rid of that expense. We’ve all heard the unfortunate stories of those who died young without insurance, leaving behind a family in need. Don’t let that happen to you.
We need to be covered for risks today, while planning for tomorrow, with a strategy that makes sense for not only ourselves, but for our children and the legacy that we intend to leave them with.
Josh Thompson is a financial strategist and wealth creation expert. He focuses on safe growth and more non-traditional methods for planning for the future. More information can be found about him and his company at www.becomingyourownbank.com.