What does buy term and invest the difference mean?
When you hear this phrase, it refers to the difference between the cost of insurance for a whole life policy and a term life policy, for the same amount of death benefit protection. The idea is then to “invest the difference” in cost, to receive a higher Rate of Return than you can get with a whole life policy.
I’ll get into why this is a tough comparison to make, but just so you can see what an actual difference is, I ran some figures with an insurance company I’m appointed with. Cost of insurance differs with all carriers, so I’m just running the numbers for both products with the same company to keep things on a level field. I did not try to make one look better than the other and I was NOT price shopping!
Looking at the cost of term life and whole life.
Both of the following cases assumed a standard health rating, $1,000,000 in death benefit and annual premium payments.
First, a male 25 years old can buy a whole life policy for $7,680 paid until age 100, or a term policy for $1,264 dollars paid for 30 years.
Second, a male 45 years old can buy a whole life policy for $16,870 paid until age 100, or a term policy for $3,626.20 paid for 30 years.
As you can see the term insurance is cheaper than a whole life policy in these 2 scenarios. What you don’t see (or think about) is that this is not a fair comparison.
1.) Take for instance the 25-year-old, the whole life is providing 96 years of coverage (at age 121 the product would endow), and is guaranteed to pay a death benefit as long as premiums are paid. (Look for What Is Cheaper, Term or Whole Life in another blog post). For the term, if you pass away during these 30 years in the above scenarios, you would receive $1,000,000, but a day after 30 years you receive nothing. In a very simple sense, you were renting the rights to payment for your death for 30 years, and once that time passes your agreement is over unless you renew with another policy.
2.) The whole life in the above scenarios has payments due until age 100, and then it is considered paid up, with you still owning rights to the death benefit proceeds. As long as you pay the premium with the whole life product depicted here, you retain ownership of the death benefit payment.
3.) With this company and product your death benefit rises through the life of the policy, because it is a dividend paying whole life policy, and the dividends were used to purchase more paid up additional life insurance. Dividends aren’t guaranteed and may be more or less favorable through the life of a policy, but if dividends were paid exactly as depicted in the illustration on the 45-year-old, the death benefit would be over $2,000,000 at age 85. Finally, the term product is a level death benefit.
What other things need to happen to make buy term and invest the difference work?
Okay, I want to move on with more of the problems behind buy term and invest the difference. This is going to require discipline on your part to invest the difference and not spend it. You should also consider where your expertise is and plan for where to invest your money. For example, do not blindly put money into the stock market if you don’t understand it, have a strategy. At Cash Value Solutions we encourage all our clients to understand what they invest in. You should have a real idea of what you can make with your money.
Is the popular invest for 12% in mutual funds realistic?
It may be for some, and not for others. Here is a great exercise for you. Look at where you are currently investing money and find out what you’re making. For simplicity you don’t need to figure taxes, but know that this is a gross number and the more you make, the more they take (they being Uncle Sam). You could use thecalculatorsite.com, but calculators are everywhere online so choose one you like.
When you pay premiums into a dividend paying whole life policy, it is NOT investing.
Investing involves the chance of loss, which cannot happen with dividend paying whole life insurance. Whole life is a solid foundation on which you can build your finances. You get unmatched guarantees to any other financial product, and when you use the proper companies, you can participate in the profits through dividends, which are on top of your already guaranteed growth. There is no risk with whole life insurance.
Investing the difference with qualified plans involves risk.
When you invest through a qualified vehicle such as a 401-K at your workplace, you are taking all the risk typically (unless you have an annuity inside your 401-K for example). You don’t have any guarantees that you will have more money than what you put in, and may have given up a substantial amount of control for what your money can be used for.
An advisor is paid a fee for managing the money, and he is paid whether you make or lose money. When you choose to defer taxes there is a larger pool of money that the advisor collects a fee on, compared to dollars you receive after all taxes are paid on distributions. Qualified plans fit some people’s financial goals, but these are things to think about when planning for your financial future. Education will help you more than anything when deciding the financial path that is right for you. (Qualified Plans were used as an example because they’re relatable and popular to many people.)
Term life is a temporary solution and whole life is a permanent solution.
A term policy can solve a short-term need for coverage, after a mortgage or business startup expense for example. As you continue through life though, it is likely that you will have debts that you want to be covered if you die unexpectedly.
For example, if you have $500,000 of liquidity, and you take out a $250,000 mortgage, your spouse could pay this off if you unexpectedly pass.
Do you think she may need that money to live?
I’m just trying to keep you thinking here; you will most likely continually have debts throughout your working life, and they will likely continue to get bigger as your income rises, it’s just human nature.
With Dividend Paying Whole Life, you have permanent protection. The companies we work with have very flexible premium options, and we can solve for an increasing death benefit to provide you with more protection as your income rises. You have accessibility to the cash value for any reason you can think of, with no questions asked and free of penalty. This next piece may be something you never thought possible with whole life too.
What if you use the cash value of your whole life policy to do your investing?
Now you have your money working for you in the whole life policy, and can borrow against it with a policy loan, to invest in anything you want (you should invest in what you know). If you should unexpectedly pass, the death benefit will be paid out to your beneficiary, minus what your outstanding loan was. You took care of investing and the risk that comes with it with 1 product! You should speak with an educated financial professional before doing this to understand the pros and cons.
How IBC solves these problems.
I know after reading some of our blogs, you’re well informed we use Whole Life in our IBC designed policies. So, how does an IBC designed policy solve for the problems rarely addressed when comparing buy term and invest the difference (for a higher ROR). A quick refresher, the problems included:
- temporary vs. permanent solution
- the need for discipline and a strategy
- no risk vs. taking all the risk
- a need for more coverage as income rises.
I want to start by saying we use IBC designed policies to perform the banking function in our lives. We are creating a solid foundation to build wealth and are providing lifetime protection to our family, with the ability to pass on a legacy income tax free (permanent solution which requires long term thinking). By controlling the banking function with our IBC policy, we have accessibility, control, and guarantees. We solved for discipline and strategy by educating ourselves first, and then implementing the IBC. We have no risk of losing our money, and have the ability to borrow against our cash value if we want to chase investment rates of return (which you can lose money doing). We attach the PUA rider to policies to turbocharge cash value growth, which buys paid up additional life insurance, and increases our coverage through life.
One final thing to touch on is we can use our IBC policy to provide passive income in retirement as well. If you fail to invest the difference or have paltry results, you could be missing this important piece to financial freedom later in life.
Book your IBC Discovery Call for any questions or to discuss what a plan would look like for you!