Personal Finance

Term Life vs Whole Life Insurance

Life insurance is a complex topic and one which you are well served to become educated about before visiting with a well intentioned and commission-motivated insurance salesperson. Insurance salesmen are trained to sell you insurance. They may have good intentions to teach you about insurance, but in the end, they get paid a commission if they sell you insurance, so they are going to do everything they can to sell you insurance which makes them the highest commission.

There are basically two competing types of life insurance on the market: term life and whole life (also called permanent insurance). Term insurance is sold for a term, generally 20 years, while whole life insurance is sold as an investment product allowing you to “invest” money, borrow against it while you’re living, and still have value left when you die. Generally, term life insurance is the best life insurance option available for the masses. Let’s do the math:

For a 30 year old male in good health, 20 year term life for $500,000 of life insurance coverage is $22 per month. A whole life (universal life) insurance policy for $500,000 of coverage is $213. That’s a difference of $191 per month!

But wait, the whole life is an investment. According to Fortune magazine, the average whole life rate of return is 2.6%, for universal life 4.2%, and for variable life (invests in mutual funds), 7.4%. Let’s do some quick calculations:

Whole life: $213 per month at 2.6% for 35 years = $146,817.19

Universal life: $213 per month at 4.2% for 35 years = $204,225.88

Variable life: $213 per month at 7.4% for 35 years = $414,222.09

Investing: invest the difference, $191 per month at 10% for 35 years = $683,306.64

Investing: invest the difference, $191 per month at 12% for 35 years = $1,108,097.46

Save the Difference

If you take out a term life insurance policy, you can invest the difference in a high growth mutual fund and be a millionaire at age 65. One of the quick arguments against this back of the envelope calculation is that most people do not have enough will power to invest the difference that entire time. You can solve this problem by creating an automatic withdrawal each month into a money market account. Have the insurance paid from the money market account and have a monthly sweeping take the rest to invest in your choices of mutual funds or in a Roth IRA.

Choose Term Life

Unless you have complex estate planning issues, term life is the best deal for life insurance. It is far cheaper and the investing power you have outside of it will make you “self insured” before your death – you won’t have to rely on the insurance policy to fund your estate.