The thinking behind this strategy initially appears very sound. The cost of whole life insurance is more expensive than term in the early years of a policy. Therefore, you should buy the same coverage for much less premium using a term policy and invest the amount saved between the two premiums into mutual funds. This difference, over time, will create more wealth for you and your family, while at the same time giving you plenty of coverage should you die prematurely. When you get older and the term policy gets far more expensive due to your advancing age, drop all coverage because you will have accumulated enough wealth for your retirement and leave money behind for your estate.
When I was 22 and wet behind the ears I thought the above paragraph was gospel and preached it to anyone who would listen. As with most great myths, there is always some truth and this is no different. The costs of whole life premiums are more expensive in the early years for the same amount of death benefit when compared to term rates for the same coverage.
Now here is the other side of the coin on the rest of the myth. Nobody (or very close) actually invests the difference in their premiums into an investment vehicle. So if their whole life annual premium is $3,600 and their annual term coverage is $600.00 the theory is they are saving $3,000 annually or $250.00 per month. If they put that amount every month inside a mutual fund then in 30 years they will have loads of money. The biggest hurdle is putting away that $250.00. If you are still a “buy term and invest the difference” kind of person, have you done what is described above? If you have, congratulations you are part of the ½%. Almost nobody is actually implementing this strategy but plenty are talking about the theory.
Financial success is not about theory but about actual results. If almost nobody is using the strategy, than it’s great for sound bites, but lousy for results. Let’s also examine the need for life insurance toward the end of your life. You need to look no further than the ads on television to see the huge market for life insurance at the end of your life. Big companies with celebrity spokespeople have been on the air every day for over a decade paying for advertising selling small, end of life, burial insurance. The advertising budget alone is staggering which asks the question, “How many policies do they have to be selling to pay for that advertising, their other expenses, and make their profits”? The non-scientific answer is a whole bunch! However, according to CSG actuarial in 2013 over $400,000,000 worth of these policies were sold spread out over 613,000 people just in that calendar year!
What does the information tell you about this nation’s financial model? Why would you buy one of those expensive policies in your later years? (Yes, they are expensive in relation to the amount of coverage you receive for your premium) The only reason is because you are not sure if you have enough liquid money saved to bury you and cover your final expenses! This is a great barometer of how, “buy term and invest the difference” has done servicing the American public.
In my own life, my mother passed away in 2010 just after the huge economic collapse of the previous couple years and before any real rebound in any of the financial or real estate markets. My mom had done well for herself and worked hard starting at the age of 17 years old. She certainly had acquired enough to cover her final expenses and leave behind a nest egg for her three children. However, she happened to die at a very inopportune time in financial history. Her home had decreased in value by 35% as did most of her investments (my Mom was very independent and did not ask for my help until the damage was done). I found out she had most of her money inside market vehicles that had gotten pounded during the previous few years.
So when she passed away she left considerable less of an estate behind than she believed she was going to just a few years earlier. She was not unique in her circumstances because that same scenario happened to many millions of Americans who passed away during those years. I am very grateful for the money she did leave for me and my family and we are fortunate that we did not “need” her money to survive. However, she really had no business being in mutual funds or stocks at that point in her life.
Had she been shown how a properly designed permanent life insurance program worked she could have long since stopped making any premium payments, had much tax free cash for her retirement years, and left behind hundreds of thousands of dollar more in her estate with a guaranteed death benefit. Many times it’s not what you don’t know that hurts you the most, but rather what you think you know that is false that’s the real killer.