Why Term is Better Than Whole Life Insurance

For the vast majority of people, term life insurance is a much better choice than whole life insurance and I am going to show you why.

Term Life Insurance TruthPrior to writing this, I did some research on the topic to see what was readily available for consumers. I was shocked to see how much misinformation is prominently displayed on some of the top financial sites across the web. Nearly every major publication has somewhere in their life insurance categories, a complete guide to why people should buy whole life insurance.

And then it hit me. There is so much money to be made in the whole life game, that you have an entire industry going up against a few people with calculators who are actually doing the math. Not to mention that most of these guides were written by “insurance experts,” also known as insurance sales agents, who have everything to gain by spreading this misinformation.

Well I am one of those people with a calculator. And I am going to show you the math.

The Scenario

Let’s take a 30-year-old male, married, with a couple children. Perfect candidate for life insurance.

According to State Farm, he can get a 20-year term life insurance policy with a face value of $1,000,000 for $48 a month. This rate assumes no tobacco use and excellent health. The same 30-year-old male can get a whole life insurance policy for $915 a month.

So to recap:

  • 30-year-old male
  • Married with two children
  • Excellent health
  • $1,000,000 policy
    • Term – $48/month
    • Whole – $915/month

Of course the whole life premium looks very high compared to the term, but they are not the same products. To be fair, whole life doesn’t expire and there is a savings aspect that builds cash value over time. That means you can use some of that cash later in life, like money from a savings or retirement account. Just do not kid yourself and think that cash value is going to grow to anything sizable, because it won’t.

Now for the Math

Insurance Math BreakthroughThis 30-year-old decides to go with term life insurance and invest the difference in premium between the two policies. That means each month he puts $48 into life insurance and $867 into an investment account. Effectively, he is paying the same amount as just buying the whole life policy, except he is saving and investing himself.

For many people that are unable to max out their 401ks and other retirement accounts, that is a great place to put these extra dollars. But for this example, it really does not matter.

For 20 years he invests $867 in a few different mutual funds and earns a reasonable return of 7%.

After 20 years, the kids are grown and out of the house. They are probably done or close to being finished with college. Hopefully there was actual retirement savings going on, and the house is probably getting close to being paid off.

What about the investment account he has been putting $867 a month into? It’s now worth over $450,000.

Now there is no life insurance. But for the vast majority of people in this situation, they would no longer need it. The kids are gone, the bills are getting paid off, retirement savings has been growing, and not to mention the nearly half a million dollars saved just from the difference in the whole life and term life insurance policy.

For argument sake, let’s say this guy just really wants to have another life insurance policy. Since the majority of people are still healthy enough to buy insurance at 50, he could buy another term policy. According to State Farm’s website, a reasonably healthy person (downgraded his health a bit) could buy another 20 year term policy for $212 a month. But there is a good chance that policy will cost more 20 years from now due to inflation, so we will double it and add a few to make it an even $500 per month.

So let’s do this again. Now this 50-year-old, reasonably healthy guy with no kids to raise still wants a $1 million policy that costs $500 a month. So he takes $500 and pays towards his term policy and puts the remaining $415 into the same investment account that is already worth over $450,000.

When this person turns 70, his term life insurance policy will expire and his investment account will be worth almost $2 million dollars.

So in this scenario, he never had less than $1,000,000 of life insurance until reaching the age of 70, at which point he had almost $2,000,000 saved just from investing the difference in the two premiums. And here is a little news flash, in those 40 years, the cash value of the whole life insurance policy would be a very small fraction of the face value, not even remotely close to the $2 million he saved by investing himself.

Why Whole Life is Sold So Aggressively

Whole Life Insurance SalesmanYou should know that life insurance agents often make close to 10x the commission from a whole life policy vs. a comparable term life policy. That is why they are so heavily pushed by a lot of agents. This doesn’t mean whole life insurance agents are bad, though. Many of them truly believe whole life is a better product, because they read the same marketing material produced by the insurance companies.

At the end of the day, for most people whole life insurance is a flat out rip off. Insurance companies and agents make a lot of money off of these policies, and that is why they are so heavily pushed. If you are being shoved into one of these expensive policies and are actually considering it, find a not-for-profit financial planner that charges by the hour (not commission) to review your personal financial situation. They can give you an honest opinion as an industry professional that has nothing to gain either way.

Disclaimers

  • This is not one-size-fits-all, but it is a one-size-fits-most.
  • If you make hundreds of thousands of dollars a year, have millions in assets, and have all retirement vehicles maxed out, there may be a place in your portfolio for whole life insurance. For everyone else, there usually is not.
  • The rates of return listed above are not guaranteed. 7% is a reasonable rate of return for a well-balanced stock and bond investment portfolio based on over 100 years of stock market data.

Comments

  1. Brad says

    I happened to take college classes in Life Insurance and Estate Planning, and have learned more since.

    I am by no means an expert, as Eric is striving to be. His story centers on an age old comparison that has been true for 50 years or more.

    However, there are caveats. There are cases when some form of whole life does make sense (btw Universal Life is a type of Whole Life).

    For instance, very few of us actually “invest the difference”.

    For those who tend to spend, rather than invest, whole life can be a better option since:
    1. the low interest rate offered by whole life is greater than 0%
    2. borrowing from life insurance is harder to justify when funding unnecessary purchases
    3. it provides an asset than can be borrowed against in case of true emergencies

    One other VERY important detail, is BUY guaranteed life insurance when you are young and healthy. A simple detail like your doctor giving you an anti-depressant to “take the edge off” and you will find the only life insurance available to you as an individual will be VERY expensive.

    • Eric Stauffer says

      Hi Brad,

      Thank you for taking the time to reply.

      Your comment brings up a good point, in that many people have difficultly with saving for retirement on their own (which is why auto-enrolling employees in 401ks is becoming popular). While this in fact is true, that is more of a psychological discussion.

      The true purpose of this post is to combat the life insurance agents out there that spew misinformation in an effort to sell higher commission products.

      Whether you have the discipline to save on your own will be up to each individual. But it doesn’t change the math.

      Thanks again for your insight.

      Best,
      Eric Stauffer

      • Michael says

        This article is misleading and doesn’t tell the full story. Also there are participating whole life policies that grow cash value, anddeath benefit. In most scenarios participating life insurance will offer more protection and cash value with less risk then the article’s suggested buy term and invest the rest scenario. I can prove it I have access to these products and I have the nbers to back it up

        • Eric Stauffer says

          Hi Michael,

          Thank you for taking the time to comment.

          The overwhelming consensus from financial planners that do not have any incentive to sell life insurance agree with the premise of this article.

          Unless insurance companies have guaranteed access to investment opportunities that can grow at a rate higher than the market average, cover their costs, and make extra so they can profit, the numbers just do not work out.

          Best,
          Eric Stauffer

  2. Kelly says

    I was checking on Knights of Columbus Life insurance policies to see if there were any complaints and came across your messages. I signed contract today called a modified Endowment Contract so my children will not have to pay taxes on the money when I die. I am to give the agent $100,000 check the day after the holiday. Am I stuck with this now. I am having second thoughts and wondered if I should have had a lawyer look over it. I am supposed to be guaranteed $128,000 upon death. I just turned 80 years old and I am in very good health. Taxes would have to be paid only if I made a cash withdrawal. Need your valued opinion please.

    Anxious to hear your advice.
    Thank you.

    • Eric Stauffer says

      Hi Kelly,

      I would absolutely speak with an attorney that can give you personalized advice. These matters can be very complicated, and policies can be written in a way that isn’t easy to understand outside the industry. Its always better to get a trusted third party that can go over the specific details of your scenario.

      Best,
      Eric Stauffer

  3. Meagan Wallace says

    Good Dialogue.

    What are your thoughts on Indexed univeral life insurance? You only mentioned Whole and Term, but nothing on UL. From what I know Indexed Universal Life Insurance comes in different forms from the basic fixed-rate policy to variable models that allow the policy holder to select various equity accounts in which they can invest. This type of policy gives the owner the opportunity to allocate cash value amounts to either a fixed account or an equity index account.

    I believe the different products serves different purposes and benefits, it depends on what the policy owner wants. The agents all belief that his or her way is best. I believe that IULs offer a more compelling story and therefore should be crowned heavyweight champions for those wanting to build wealth without the risk of the market.

    • Eric Stauffer says

      Hi Meagan,

      Thanks for taking the time to comment.

      In my opinion, indexed universal life insurance is not a great place to put your money either. The sales pitch is often excellent growth without the market risk, which anyone in the financial services industry knows is not the case. You really can’t have one without the other, especially with interest rates where they are today.

      The bottom line is insurance companies have to make money. So bundling life insurance and investments doesn’t magically create a larger return for the consumer. The insurance company needs to get their take somewhere, and they certainly will.

      There are certainly places where these types of products can fit (estate and tax planning situations) but for the vast majority of people, investing and insurance should be separate.

      Best,
      Eric Stauffer

  4. Mike says

    Eric, thank you for this article, I’ve been doing the same analysis for whole life and term 80 plans. I’m glad that you factored in inflation. I assumed a 3% inflation for all my analysis.

    What I have found for whole life, is that if you make more than 2% – 4.5% on your investments, which should be terribly easy, you are better off getting term and investing. All of my analysis was based on being insured until age 65. It also assumed that you would convert your Whole Life into an annuity and forfeit the insurance value at age 65. Otherwise you have to borrow against a whole life and you are losing 4-8% of your borrowed value in interest every year, which is not feasible when using this for income for over 6 years.

    For Term 80, you are better of keeping term up until 70. If you really want to keep going to 80 the insurance can go either way. This analysis assumes that you are able to re-buy insurance to extend and that you do so at the soonest possible to lock in a 30 year rate up to the age you would like to stop insuring (Ex: If you want to go to 80, you get in a 30 year term at 50). However it also factors in that you always have a 30 yr policy so that you can give yourself extra “insurance” if you are unable to re-buy (ex: if you are 30 now and want to go to 80 you opt for a slightly more expensive 30 year term then cancel is at 50 when you lock in another 30 year term. This way you will still be insured to 60 if your now uninsurable).

    The only advantage to term 80 is that you don’t have to re-buy and thus you are not at any risk of not being insurable again later down the road.

  5. Regina Shay says

    Thank you so very much Eric for posting this article!!! After 8 years of paying between $800 and $600 a month for child support – it’s going to be finished in June – my husband and I are going to get life insurance for ourselves. I was an insurance agent MANY moons ago…however…it was for auto-homeowners and commercial…therefore had little knowledge of life insurance. I wanted to check out the facts and get quotes from other companies before speaking with our State Farm agent…I am VERY glad I did!!!!! Thank you again for this article!!!! God Bless!!!!
    Mrs. Regina Shay

  6. Sandi says

    Great article! This helps me, as I’m currently looking into which type to get again, and I fit in your scenario of the almost 50 year old looking for a second term.

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