- Whole Life, Term Life, are you confused about your options?
- Did a local agent insist you needed whole life so you could be covered forever?
- A Comparison of Whole Life vs Term Life Insurance
The Whole Life and Term Life Options:
The good news is that for a healthy forty year old women there are lots and lots of options for life insurance. Being that women tend to live longer, their rates can often be less expensive. Across the board this is the case in the world of life insurance.
Our candidate, lets call her Mary, is 40 years old. She does not smoke, drink excessively, and has essentially no major health problems. She sees a doctor regularly and has the occasional ache, pain and cold, but no long term health issues. She works in an office, is married, and spends time with her young boy. She does not have any accidents or tickets on her driving record and does not participate in any dangerous activities such as hang gliding, scuba diving, etc. In other words she is a classic candidate for Super Preferred Pricing.
The options for life insurance for Mary are many. She can purchase a type of Permanent life insurance called Participating Whole Life, or Universal Life. Within the subcategories of Universal life there are many options as well. She could contact a registered broker and purchase a variable life insurance contract. (NOTE – I am not a registered broker.) Of she could choose from the multiple multiple term life options, including 10, 20, 25, 30 and even something called Return of Premium Life Insurance. This is not a complete list of Life Insurance options for Mary. But it is a good start.
After reviewing all of the options Mary boils it down to two ideas that catch her eye:
The Whole Life Insurance Pitch and the Cheap 20 Year Term Life Idea:
She is attracted to whole life insurance because she is told that it is coverage for her entire life and she likes the idea of investing in a safe method. Of note is that the “cash account” in a whole life account is not really investing as much as saving money away. However she is greatly concerned about the complexity. The agent that suggested the product wants to meet her at her house and asked her to bring her checkbook.
She also is interested in Term Life insurance, partly because she heard it recommended on the radio. It sounded cheap. She called up an agent and got a quote in five minutes. She compared the quote with one that she found online and received ‘similar numbers.’ She is confident that she understands the Buy Term and Invest the Rest philosophy, but is unsure of how long to get the policy.
An A+ Rated Carrier:
For a comparison to make any sense, we must choose one carrier and compare their Term vs their Whole Life Option. As the agent writing this, I choose the carrier. It is a carrier that I feel has fair prices both in the arena of whole life and term life. (Curiously this carrier also allows for a slight premium increase for a convertible term policy that may be amended into a whole life policy. But this is a story for another day.) The carrier selected, lets just call them XYZ Life, is an an A+ rated carrier that is over 100 years old. AM Best rates insurance carriers by a number of rating factors, A+ is considered to be one notch below top, which would be A++. None the less, A+ is considered to be very secure.
In the case of a term life policy, the financial strength rating matters, and it matter a lot. In general I would not suggest anything under an A rated carrier. For a whole life policy or any life insurance policy that carried some sort of cash account, the credit rating is very important. Why? Well, being that some of the money sits in a cash account, and the insuring carrier is contractually obligated and bound by the contract, how they handle your money is extremely important. As private citizens there is really very little we can know, let alone understand, about how these public companies invest our proceeds. Th financial strength rating is really the best chance for the typical american to understand and assess an insurer.
The Financial Costs for Whole Life and Term Life:
A whole life policy, $1,000,00 policy, from XYZ carrier, A+ rated, for a 40 year old female, non smoker, as a super preferred, would cost you $9,925 per year.
A 20 Year Term, $1,000,00 policy, from the same XYZ carrier, A+ rated, for a 40 year old female, non smoker, as a super preferred, would cost you $515 per year.
The total amount spent on a Whole Life policy from XYZ would be $595,500 until she reaches 100 years old.
The total amount spent at age 60 on a Whole Life policy from XYZ would be $198,500.
The total amount spent on a 20 Year Term Life policy from XYZ would be $10,300, until she reaches 60 years old. At age 60, her coverage would end.
|Insurance Type||Whole Life||20 Term Life|
You may have noticed the extreme difference in cost between the term and whole life examples. Any analysis of the difference between whole and term life, must involve the use of the excess funds.
The Excess Term Life Money:
What to do with those extra funds? How do we value them?
Generally the best example is to imagine that these funds will be invested. Some insurance agents will insist that most people will not actually invest the difference therefore its not a fair comparison. That may in deed be true. However, what that same insurance agent may not be telling you is that a large percentage of whole life policies are cancelled in the first ten years.
Obviously there are lots of reasons for these cancellations, the number one probably is the high cost. What may look affordable year one, may not be affordable year nine.
For the purposes of this comparison we will calculate the excess (unused term) cash at the following rates:
1% as in a typical online bank.
3% as a a possible tax free bond fund.
6% a possible average stock investment return.
The growth of the Whole Life Policy will be represented by both the guaranteed values and assumed values based on the carriers past payment history. Of note is that with all investments past investment payout is no guarantee of future payouts. In this era of low interest environment, a consumer should be very careful in assuming that this would be the case.
The Whole Life Cash Account Growth:
Whole life insurance cash accounts generally grow because of dividends. It is much more complicated than this of course, but this is the simple explanation. These payouts are subject the insurance companies internal rate of return.
The Tax Consideration:
Whereas the money that grows in a whole life policy may be earned tax free at the time of your passing and the dividends may accumulate tax free, the excess term money that grows outside of your whole life account may indeed be taxed. However, that of course depends on where and how that money is invested. Certainly if the excess term money is invested in a Roth 401K, Roth IRA or Backdoor Roth IRA, or possibly an HSA, it may be tax free. If the money is placed in an IRA, or a 401K it will be tax deferred. If the money is invested in a tax free investment such as a State Municipal Bond fund, it too may be tax free. It of course can also just be intelligently invested in a tax mitigated strategy, whereby it is taxed, but at a much more managed and hence-force, differed rate. Therefore, I find that that the tax consequences in any of these comparisons to be… mixed, and really unusable.
Therefore rather than try to account for the tax advantage / disadvantage of either, I will just show you the raw numbers and let you the consumer make up your own mind.
The Account and Cash Growth of the Whole Life Policy:
The whole life insurance policy, with a guaranteed death benefit of $1,000,000 can receive additional death benefits from dividends. As an owner of a whole life policy you will have a few options of what to do with the death benefit. For the purposes of this comparison we will be using Mary’s dividends to purchase additional insurance.
After 20 years of making $9,925, each and every year, your guaranteed value value of death benefit will still be $1,000,000 and your cash surrender value will be $238,120.
Or after 20 years of making $9,925 each and every year, your possible assumed value (using XYZ life insurance estimates of dividends paid) of death benefit might be $1,044,944 and your assumed cash surrender value might be $256,826.
How did that compare with term and the Side Account? Lets see.
The Side Account Cash Growth and the Term Life Policy:
The Term life policy carries no cash value, it only has an insurance value of the same $1,000,000 for the life of the 20 policy. The side cash/investment account will grow, we will compound and invest it annually for twenty years, at the three rates show above.
Each and every year you will have $9,410 to invest. If you invest the same amount of money each and every year than with a simple one time yearly compounding at a 1% rate of return you would have of $209,270.82.
With a 3% rate of return you would have of $260,532.65.
With a 6% rate of return you would have of $366,921.56.
Whole Life vs Term with Side Account Chart:
|After 20 Years of Making Payments|
|Whole Life||Term Life|
|Total 20 Year Outlay||$198,500.00||$10,300.00|
|Guaranteed Coverage Amounts||$1,000,000.00||$1,000,000.00|
|“Possible” WL Coverage Amount||$1,044,944.00|
|“Assumed” Surrender Value||$256,826.00||$0.00|
|1% Rate of Return with Excess Cash||$0.00||$209,270.82|
|3% Rate of Return with Excess Cash||$0.00||$260,532.65|
|6% Rate of Return with Excess Cash||$0.00||$366,921.56|
In Summation of A Comparison of Whole Life vs Term Life Insurance:
Mary can buy a $1MM Whole Life policy and pay $9,925 per year and at the end of the policy possibly and have a $1.044 MM Death Benefit with a perhaps $256K cash surrender account. She will need to keep making her yearly payment of $9,925 per year for the rest of her life.
Mary can buy a $1MM 20 Year Term policy and pay $515 per year and at the end of the policy no longer have a Death Benefit, but have perhaps $366K in savings. She will no longer have insurance payments from then on and will be able to save the full $9,925 per year.
|What Should Mary Do?|
|20 Year Term Life||$1MM||$515||0||$366K|
Of note in both of these scenarios is that these are ideal situations. The yearly premium and yearly side account investments are made on time, each year. Rarely, if ever, does this happen. Has the client budgeted in buying a new car, or replacing a roof? The numbers will play out much more favorably for the Term and Side Account, should she not be able to come up with the full $9925 in a given year. With the term policy, you just need to pay the $515 charge. With the whole life policy, it becomes messy and your savings account will truly plummet.
The Decision is yours:
What should Mary do? Should Mary sign that Whole Life contract? Should Mary go with the simple term life and invest the rest?
Mary’s decision is not easy when initially confronted with the two choices. Is it a question of the simple easy answer vs a life long decision? But which looks better on paper? Which gives her more control? Is it realistic to assume that She can afford an almost $10K annual payment each and every year for the rest of her life? Mary of course is a fictional person. If your name is Mary and I have sold insurance to you, this is not you. The choice presented here is a choice that countless American families are confronted with. Should I try and save money in my whole life insurance policy? Should we just go in the simple understandable direction?
Personally and professionally I think the decision is pretty simple. What will you do?
But wait you may say, my analysis is short sighted, because its only a twenty year comparison. Or you are assuming that Mary still has room left to invest the money in her 401K. This is just one 20 year scenario, this is not the full panorama of time frames and investment considerations. Yes, there are situations when very well to do people can choose whole life insurance and financially come out ahead. This is just one scenario, but a pretty common one from where I sit. And there are other reasons why whole life may be the best choice for you. These include, but are not necessarily limited to: Funding a Special Needs Trust, Use for Business Insurance, or for extremely wealth Americans. Even for people that can not qualify for term life a version of whole life called Final Expense may be their best choice.
One last note, this analysis is only a twenty year analysis. From 20 years on, the product could play out differently. Tales of successful whole life insurance placement do exist beyond 20 years. We will explore these numbers another day.
The Author’s Bias?
Some would argue that because I have a term life rater on my website, I am biased towards term life insurance. Actually I’m biased in the clients direction. But finding the clients direction involves running the numbers. I can sell a prospect either a whole life or a term life product. If you think that I make more money selling term polices that whole life, you would be incredibly wrong. For years whole life agents have been knocking on doors, cold calling clients, and sidling up to them at mixers. Term life commissions really don’t pay for that. It has existed for years as an 1-800 option. Now with the advent of the internet though, term life can come to you from licensed agents.
This post was written, computed, and edited by Scott W Johnson – California License 0H11625. Thanks for reading A comparison of Whole Life vs Term Life Insurance for a 40 Year Old Female.