When Does BTITR Not Work?

When does Buy Term and Invest the Rest Not Work?  Buy Term and Invest the Rest, abbreviated as BTITR is the financial philosophy of buying term insurance vs whole life insurance.  Buy Term and Invest the Rest also goes by the term Buy Term and Invest the Differences, abbreviated BTITD.

BTITR = BTITD

At WholeVsTerm we have written extensively in favor and defense of the value of buying Term instead of whole life for the vast majority of American Consumers.  But in this short article we will discuss when this concept might conceptually lose out to a A+ Rated Participating Whole Life Contract.

So, When does BTITR Not work?

There exists in most full analysis of Whole Vs Term a period of years right after the term policy ends, when Whole is often the best choice.  At least from an absolute dollar perspective.  These years, I refer to as the Gap Years.  When analyzing these concepts -  that quantity of the gap years can make or break your decision. I have seen reviews when there were only three or four gap years and situations when it is five or eight gap years. In our example from one of our articles we show that a theoretical client 'John'  "comes out financially ahead if the whole life policy were to pay out between years 20 and 27."  In that example there are seven gap years whereby if death were to occur, its likely that for those seven years that Whole Life would have been a better call.

The issue with reading this is walking away thinking, oh seven years - Lets Get it.  But wait, seven years of a lifetime of money and coverage. That example involved a 40 year old, considering a participating whole life policy.  For a 40 year old, let us assume a lifespan of 40 remaining years. 7 of 40 years is only 17.5% of the time would Whole Life made more sense vs 82.5% for the BTITR.

The calculation of gap years though involves a numerical problem of reality. Since we can never really know what will happen in any ensuing 40 year time period, we are making many assumptions. Those assumptions to some extent always are partially incorrect. It is possible that the gap years are figments of our financial imagination because the client is never truly able to afford to pay the whole life contract for the entire time span.  Often this is the best reason to choose the choice that contains the most options.

That being said, the prevalence of the Gap Years are possibly the biggest thorn in the side of Buy Term Invest the Rest proponents.

It is possible that if a major financial downturn were to hit America, that a Mutual Whole Life Contract could end up having been the best bet.  The best historical example of this is of course the Great Depression. The stock market rout that started in 1929 sunk to a low of 41.22 in 1932. The 1929 high point of 381.17 on Sept. 3 did not fully and completely recover until Nov. 23, 1954, says the New York Times. Of Course -"stating market returns without accounting for deflation exaggerates the decline."

So the question from this historical example is - If the Stock Market were to go down and Stay Down for 25 years, Would a Whole Life Policy make More Sense than BTITR?  The short answer is: Its Unclear.

I realize that some will scratch their heads at my conclusion on this one. Really, its not clear that a Whole Life policy would be a better bet if the next Great Depression were to come?  Correct, it is not absolutely clear to me, although my guess would be that it probably would be a better place to have your money, but given that so many variables would be involved here = it is just unclear.

So what are these variables?  There are three major ones:  The Investments, The Insured, and the Insurers:

Lets tackle the investments first.  If we stick close to our historical example, then we assume that a 1929 example would involve most banks going out of business. I presume that that would mean that many non bank financial companies also would go out of business. Most corporations will stop paying significant dividends and the unemployment rate might top 24.9%.

So does this mean that our Investments purchased in our 401Ks and Roth IRAs are completely worthless? Does this mean that we will never be able to retire?

For the Insureds: Going back to our unemployment rate we can also safely assume that those that are still working on average are making less money.  Will the average person that purchased that Whole Life contract be able to afford it still?  My guess is that at least 30-40% of those, easily will not.  So was the decision to purchase a 10 times more expensive whole life insurance now seen as a blessing or a curse?  It depends, if they followed my advice to only purchase whole life insurance once you have a 6-12 month back up fund reserve fund, they might be a slightly better spot.  However even that amount will not be enough.

The Insurance Companies are the one variable that is probably worth the most discussion. Focusing on our past historical example we know that about 6% or so of insurers went bust during the depression. (Although I have seen different numbers represented.) Not at all a high number compared to banks.  But it is not nothing. It is not insignificant.

There are two main questions that we need to consider: 1. Will Life Insurers Stay in Business and 2. Will Life Insurers keep paying out policy dividends?

1.  Life Insurers Staying in Business: Assuming a client has stuck to our opinion to only purchase whole life policies from A++ and A+ participating insurers, I cannot say what percentage could go out of business in using this historical example.  My best guess is that it might be less than the 6% number, perhaps just 3%.  So I believe that this might be the lesser of the two concerns.

2.  Will Participating Whole Life Insurers Still Pay Policy Dividends:  I can imagine an entire article dedicated to this very topic, because it is so complex.  Policy Dividends are paid out to owners of Whole Life Contracts when the insurer has excess yearly money. They are in essence income from the Mutual Insurer?  

But will Insurance companies still be profitable during a depression?  According to the Atlantic, during the Depression, "suicide rate spiked to its highest recorded level ever: more than 150 per 1 million annually." Callously, this could really be an issue for insurers.  And its not just suicide, but general less healthy living and more early deaths.  

But the even less talked about issue is of insurers keeping up dividend rates during a prolonged downturn in the economy. Insurance companies themselves, hold lots of financial assets = Treasuries, Bonds, and Even some stocks.  So if the stock market and bond market tanks, what happens to insurer's balance sheets. During the past decade insurers have struggled to pay high dividends with the federal reserve funds rate being so low.

Therefore as we have demonstrated: Yes Whole Life Insurance Probably is a Better place to have your money during the next Great Depression, but it probably will not pay the incredible dividends pitched to you and some of the insurers will go bust.  A large remaining issue is that annual policy premiums need to be paid to keep the policy in force and when a third of the work force is not working, this plan just might not work.

This potential situation is out there. The idea being that somehow someway our society and its' financial system fail to work for some unknown reason. But, life insurers stay in business and continue to pay out solid dividends. Although there is not a large possibility of this, it could happen.

I have said on numerous occasions that the A+ and A++ rated US life insurers are some of best and most stable financial organizations in the world.

The argument that is brought up often by sales agents of these contracts is that since so many people do such a poor job at saving money, they might as well choose a forced 'savings' plan. Occasionally some of these agents will admit to their poorer performance but point out that still, forced savings accounts might make more sense.

There is an element of logic to this. It is possible that some people could, in theory be better off with this economic concept. There are still two major elements issues. First off, a rather large percentage of people that purchase whole life contracts cancel them in the first ten years.  Second, if we are referring to forced savings accounts, than a work sponsored 401K would seem to be in competition for your dollars. In general we almost exclusively believe in the superiority of the 401K vs a whole life contract.  So this concept really only may work for those that are already maxing out their 401K accounts.

However if you are an individual that can ONLY save via a forced savings account AND are already filling up your forced 401K account, than perhaps the competing BTITR might not be the best option for you.

A special needs trust, as listed in our Best Uses of Whole Life Insurance, is simply a Trust set up for your children that likely will need financial assistance for their entire life.  Children that will not be able to care for themselves.  I admit that the inclusion of this reason, perhaps is so specialized as to not be worth a mention. However for completions sake, why not. For a family that early on realizes that they have a child that will forever need financial assistance, this is a great reason to purchase a whole life insurance policy.  Accompanying a Special Needs Trust and as the Financial Funding Mechanism, I fail to see how a Buy Term and Invest the Rest concept will beat this.

There are just so many benefits of this set up for those in this situation.

Second only to the use for a special needs trust, this concept is probably one of the very best purposes of whole life contracts. The concept of the wealthy using Dividend Paying Policies to for estate purposes is rather well known. Some people believe that just because a well known wealth individual has a whole life contract, than you should too. However this argument ignores the fact that unless you are a Billionaire, comparing your financial situation with one is not prudent.

But at Whole Vs Term, we are fans of exceedingly wealth people using Participating Whole Life Policies for the transfer of Wealth to their heirs. Often this will involve a type of a Trust, called an Irrevocable Life Insurance Trust. But this is not a cheap solution.  It is also not for the faint at heart.

So who are these people? Well, there is no simple definition. But, my calculations say they make at least $300,000 (and often more) per year, each year.  Although with income like this, it often spikes. They are easily maxing out their 401Ks, either their Roth IRA or backdoor Roth IRA, if  they have access to an HSA that is getting filled too. They have huge short and mid term reserves. They make extra mortgage payments, have an independent investment account, are properly insured with both life and property casualty. They may own rental properties. They may be invested in alternative type investments. These people have financially succeeded in almost ever way.

For these people, BTITR is not so much a failure as often something that they have already done, very successfully.  But they have amassed so much money that they are concerned by estate and inheritance taxes. They may be concerned about over exposure to the market.  They may just want a better plan.

Sometimes in best case scenarios they are signing up for a whole life contract whose yearly annual premium payments are already set aside.  There is no question of affordability here.

A convertible term policy is a policy where you have the option to change it to another form of life insurance during the life of the contract. Proponents of this concept admit freely  the prolonged affordability issue of permanent life.  A convertible policy is essentially BTITR, with an option to change at a later time.  For those of you that are all excited about getting a participating permanent policy I encourage you to further explore this solution.  This is a potential good solution.

It allows consumer to use term life during the years when they are raising their families and still gathering up savings. If near the end of the term policy they think - "hey I am doing pretty well here" - they than can seriously re explore their options.

The Convertible to Participating Whole Life Option is not perfect. First off when you buy a convertible term policy you need to focus on the insurer that you want. (This is not as simple as choosing just any old term contract.) Second it contains a obvious significant delay before the participating dividends start gaining steam. (Because you wont receive policy dividends until after conversion.) Therefore from an investment standpoint, it violates a major rule.  That rule being the time value of money equation.

The Convertible Term Life to Participating Whole Life Option remains probably the best option available for those that are considering using whole life for savings purposes and are not uber wealthy.

On this site, we really do not focus too much on business life insurance. However I am certain that there are instances when using whole or universal life insurance for a business reason that it could make sense. For some types of Buy Sell Agreements or maybe Key Man insurance, BTITR might not be a great option.

If for some reason you cannot qualify for a level term policy, a form of Whole Life Insurance might just be your best option. In instances when you can't qualify than 'Buy Term Invest the Rest' clearly will not work. This point is almost added as a obvious caveat. There are many that are well served by Final Expense types of insurance.

Care should be taken to confirm that you cannot truly qualify for term.  Underwriting for term insurance is easier with some carriers than others.  Check around and speak with a solid agent.

There are likely other candidates of situations when Buying Term (and Investing the Rest) does not beat out a Buying a Participating Whole Life Contract. However those potential omissions more than likely still do not make their purchase worth it. The numbers more than often do not add up for middle class Americans buying whole.  Thank you for reading When does BTITR not work.