Term vs Whole Life Insurance

Often, in the seminars and workshops we do, we are asked about the purchase of whole life insurance vs buying term life.

Before we get into the heart of the discussion, let first consider what each involves.

Term life is considered “pure insurance” and provides insurance coverage to the client for a specific period of time. In the case below, it provides coverage to age 65. It does not build cash value and pays the sum assured only if you die before age 65. At age 65, the plan terminates if you are still alive – you get no payment at this point.

Whole life provides insurance coverage for life, once the premiums have been paid as required. It will pay the sum assured on death, whenever that occurs as long as the policy remains in force. Whole life policies build cash value that can be surrendered for cash, used to keep the policy in force or borrowed against.

An important question then is why do we generally recommend term life instead of whole life?

The answer is based on need and the cost/value relationship.

Need

There are few instances in which whole life offers a better option to the client – these are for estate planning purposes or for forced savings for persons who find it difficult to save. I don’t expect that either of these situations is currently relevant to most of the persons because:

• Term plans can be converted into permanent plans if needed for estate planning purposes
• You can have money automatically deducted from your salary to go to, for example, purchase mutual funds to achieve forced savings
• Our need for life insurance is usually temporary - this need declines as we get older, have fewer people depending on our income and are able to build assets.

This suggests term insurance to age 65 (or to age 80 in special cases) will meet most of our life insurance needs. And because you can get more term insurance cover for each dollar of premium, it means that you are more likely to purchase an adequate amount of coverage, rather than be underinsured like most people are.

Remember that you should be seeking to get adequate insurance to cover all of your needs (income replacement, mortgage etc.) – this is often much more than you think especially if you are a major contributor to household finances and have children. This cover is much more affordable if you buy term insurance.

Cost/Value relationship

Further, when we look at the cost/value relationship, it totally negates the usual comment from customers about the need “to get something back” from their insurance coverage after paying premiums for such a long time. The simple principle is that insurance is NOT an investment – even if some insurance policies have been modified to provide investment options.

In the vast majority of instances, buying your insurance coverage and your investments separately will provide much better value for you than buying insurance and investment together in one insurance policy.

Consider the example below – a real life example.

For a 28 year old female (who does not smoke), a convertible term policy to age 65 for $250,000 will cost her $42.63 per month. An alternative whole life plan for the same level of coverage will cost her $140.89.

At age 65, her insurance cash value will be $117,250 having paid $63,414 in accumulated premiums.

If she had placed the difference in premiums ($98.26 per month) between the whole life and term plan in a growth mutual fund (expected to earn above 10% per annum over the long term) for the same 39 years, she would have over $550,000. If we include the tax benefit that is currently offered for investing in mutual funds, this amount will be over $700,000.

It would be difficult for us to recommend a whole life plan in these circumstances – and where someone recommends a universal life, whole life or endowment plan to you, it may not be in your best interest.  For all those who talk about the guarantees offered by life insurance, the long term track record of mutual fund investments is sufficient to provide us with comfort. Further mutual funds provide a number of additional benefits as investment vehicles including the ease of buying and selling units, diversification and lower commission-related costs.

We hope that wehave answered this question adequately and would be happy to deal with any follow up questions that you may have to ensure that you are fully comfortable – send us an e-mail if you need further information.