With a title like that, you know this has to be good. If you are new to this life insurance thing, there is a raging debate over something called "buying whole life insurance" or "buying permanent insurance" as versus "buying term and investing the difference".

First, I want to say that this whole debate about whether you should buy term or buy whole life insurance is really more of a marketing angle than anything else. You should know that, from a technical standpoint, there isn't much of a difference in how life insurance is priced regardless of the contract. The actual cost of insurance is the same. How it's paid for varies a lot though.

With term insurance policies, you are paying just for the death benefit. You can pay for the pure cost of insurance, using an annual renewable policy. Or, you can buy a level term policy which inflates the premium and levels out the cost over the life of he policy.

With permanent policies, you are doing the same thing as you are doing with a term policy, but you are building up a cash reserve as well. This gives the illusion that the cost of insurance is more expensive. In reality the cost to support that death benefit is the same, it's just that the premiums are higher due to the investment component.

What "buy term and invest the difference" really means is that you are taking a look at two different options of buying life insurance and saving or investing your money. You are either going to bundle the cost of insurance with your savings or you are not going to bundle the cost of insurance with your savings.That's all it means.

That is the essential distinction of this comparison - a distinction that most advisers ignore when it favors their particular kind of financial advice.

For both instances, you have to assume that your risk tolerance and reasons for buying a particular financial product doesn't change - and this is where most insurance agents and financial advisers foul things up. If you are changing your risk tolerance for the "buy term, invest the difference", then it's very easy to beat the whole life insurance option. The problem is that it's also easy to beat the "buy term, invest the rest" option by just not buying insurance at all. In other words, you won't end up with a good analysis of the two options.

The first scenario that you can run is to get a quote from a good stock or mutual life insurance company for a high cash value whole life insurance policy. There is a difference between this and a permanent policy that is designed either to provide both cash value and death benefit or just provide a guaranteed death benefit and not much cash growth.

You know the old saying? "Jack of all trades..." you know the rest.

Which brings me to my second point here which will tie into all of the pretend life insurance experts and what they are doing when they show you their version of the comparison of permanent life insurance vs. the "buy term, invest the difference" aka "BTID". That second point is...

Don't compare apples and oranges!

Also don't call a rose by any other name and assume that it is actually different. Comparing apples to oranges doesn't provide you with a meaningful comparison, and it's highly misleading. Find a good high cash value dividend paying whole life. Then compare it to a "buy term and invest the rest" option - and there are two ways you can do this (more on that in a moment).

I can't recommend any companies, but I can give you some shopping ideas. Met Life, Mass Mutual, New York Life, Northwestern Mutual, Mutual Trust Life, and The Guaradian Life Insurance Company of America have excellent high cash value dividend paying whole life policies.

Anyway, one of the things I see a lot of advisers and even insurance agents doing is setting out to prove that term and invest the difference beats just buying the whole life insurance option. I'll tell you right now that the trick to this shtick is to manipulate the numbers on the "investment" side when you do the "BTID" option.

For example, let's say you are 35 years old and set out to buy life insurance and start saving money at the same time. You have $200 a month to "play" with (though most people don' t think of it as playing). If you get into a nice high cash value insurance policy for $200/month, here is what your expectations should be:

You'll start out buying $135,234 worth of death benefit. That death benefit will probably grow every year due to the dividends (this is part of the reason why you use a dividend policy).

After 30 years, you are 65 years old. You have $141,766 in cash value and $259,926 in death benefit. Life insurance works in "mysterious ways" (not really, it's just that the internal working components are a bit too technical for a post like this). What this means is that over those 30 years, you've been paying less for your death benefit every single year and your internal rate of return (this is net of all fees and expenses) at the 30 year mark is 4.17% and it's always inching up every year. Also, this assumes that the "assumed" cash value growth is suppressed by .5% a year. Which means, I didn't use the company's "official" illustrated interest rate - I used a lower one.

Now, let's look at the "buy term, invest the difference" option. Let me stop you here and just point out once again that I am going to compare apples to apples, not oranges. What I mean is, and this is where almost everyone makes a ridiculous mistake, I'm not going to sit here and illustrate investment returns of 12% annually, or start buying up 3 times as much death benefit as the whole life option.

In other words, I'm not going to assume one risk tolerance for one scenario and a completely different risk tolerance for another scenario.

Why?

Because, the end result won't show an honest comparison between the two strategies.

I'm also going to call a rose a rose. For the "buy term and invest the rest", I can either: buy a high cash value universal life insurance policy - because that is "term an invest the rest" all packaged up for you nice and neat. Or I can buy a term life policy and then invest the difference in separate mutual funds or annuities or anything else. So, when we talk about "buy term, invest the difference" we are really just talking about how to buy the death benefit - and that's it. The savings can be part of the insurance policy or it can be separate.

Some folks will tell you that you shouldn't mix your insurance and your investments. When you ask them why they usually give you some kind of circular reasoning that amounts to "because insurance is insurance and investments are investments". Yep. That's true. So what? Your argument here has to be - it HAS TO BE - that the general account is somehow an inferior investment to some other kind of investment.

That's not an easy argument to make because insurance company general accounts are very, very stable. Another view that I won't get into here is that I disagree that life insurance is, fundamentally, an investment.

What universal life insurance represents is this: the cost of insurance is unbundled from the term life policy. You actually have an annual renewable term policy with a cash account invested in the company's general account portfolio (or something else if you have a variable life or indexed universal life). The cost of insurance is deducted every month from the cash account. As long as there is enough money in there, you still have the insurance portion.

Most financial planners and insurance agents (who don't support the idea of buying permanent insurance) want to say that "yeah, but you can buy a lot more term insurance when you BTID" or "yeah, but you can get a higher rate of return if you invest the money somewhere else besides the life insurance policy". In one respect, it doesn't really make sense.

I mean yes, technically, can do both of those things. It's just that, if you do, you want to compare it with an equal opposition on the whole life insurance illustration and THIS is where the numbers get manipulated.

You see, advisers are willing to show you that you can buy $500,000 of term insurance and "invest the rest" in mutual funds or something other than an insurance company's general account, but they have to compare it to an investment that is completely unlike the insurance company's general account - they have to assume that you're willing to take on a lot more risk in the investment side.

So instead of illustrating the investment as an investment of a similar type - a bond or bond-like investment - they want to show you an equity investment. Now, you may very well be willing to accept a higher level of risk in your investments. But, by switching your risk tolerance like this is bait and switch.

Don't start pitting a 4%-5% interest rate up against a 12% interest rate all of the sudden and then have an epiphany that the 12% wins. DUH! It's simple math at that point. If you want to compare interest rate environments, you don't need life insurance. You just need two different investments!

Remember, the BTID is supposed to show that whole life is inefficient vs. un-bundling the cost of insurance and using a similar investment alternative instead of the cash value option. But, the "invest the rest" is almost always shown to you by an adviser as some type of equity mutual fund or variable annuity.

It's like fixing a boxing match and being surprised when the other guy takes a fall in round 3.

If you're going to do that, why not just forget the term life insurance policy and illustrate a 100% return on your investment every year by investing in stock options or mining stocks? Or better yet, stock options on mining stocks. You won't need insurance at all after a few years! That sure beats 12%, doesn't it? DUH.

But, there's an even bigger problem comparing a contract with guaranteed growth to an equity investment. There's literally no way to accurately predict how much money you'll end up with, since you have to assume an average growth rate on your equity investment and averages can lie big time.

The underlying guarantees from a life insurance policy come from bonds and the life insurance company's management of long-term debt obligations (the bond-like investments). Sure they can hedge against inflation with futures and so on, but the basic guarantees come from bonds.

Sooooo....

I'll bet you know what's coming next don't you? So let's be honest and compare apples to apples by buying the same amount of term insurance and investing the difference in bond or bond-like investments. Maybe you don't think that that's fair?

Maybe you think that "in the real world, you have more options than investing in bonds". That's true, you do. But when you make comparisons between two things to see which one is "better", you have to first decide what you mean by "better". The mentality of a person buying a guaranteed rate contract isn't the same as the mentality of a person buying an equity investment. To compare the two using the assumption one is "better" than the other is nonsensical and cannot be answered rationally. The only way to answer which is "better", and have any hope of accuracy and meaning to go along with the claim, is to compare two similar investments. 

OK, let's move on to the BTID example. A competitively priced guaranteed level term policy - if you are buying the same $135,234 worth of term insurance - will run you $34.73, non smoker, standard (same rating as the permanent policy). Don't get all tripped up over the cost. You've probably seen T.V. commercials advertising $250,000 of term life for $15/mo. What they don't tell you is that this is for an "ultra preferred plus select" rating. As the name suggests, you have to be practically superhuman in order to get that type of rating. So for most people, standard or preferred will be what you get.

Now, invest the difference of $165.27 at 4.5% in a bond or bond-like instrument. After 30 years, you wind up with $125,974.39 in cash. That's a lot less than what you got from the whole life option.

BUT

I didn't factor in taxes and investment fees because there's always someone who wants to use a qualified plan for the "invest the rest" option and then 3 more people swearing on their dead grandmother's grave that they can get the investment fees reduced so much that the brokerage will pay them to invest in the bonds or bond-equivalent. Yeah right...whatever.

Realistically, the results for "buy term and invest the difference" would be a bit lower if you are a "normal" person.

Now, wait a second. What if you used a term with return of premium? At the end of those 30 years, you'll get all your premiums back. But, there's no free lunch. You've heard that, right? Right? The term cost for those 30 years is higher and so your "invest the rest" will be lower. It evens out quite nicely, but I'm trying to keep this example simple.

You could also combine the two and just buy universal life insurance and you'd have something somewhat similar.

So, just to sum it all up, all other things being equal, the whole life option will typically outpace a real "buy term, invest the rest" (buying a term policy and then separating the insurance from the investments and using bond or bond-like investments). It may or may not do as well as "buy term and invest the rest in equities", but the "invest the rest in equities" can be somewhat speculative, so it's hard to say (one would think stocks would outperform bonds over the long haul) and as I explained before, doesn't provide a meaningful or rational answer to the question of "which is better?"

If you have about 20-25 years to save, the permanent option is probably worth it. At 15 years, it's sketchy and depends on the situation. The longer your time until retirement, the more it favors the permanent insurance option. There are a number of reasons for this that I won't go into right now.

If you're trying to save money and you have less than 15 years, you're SOL just about any way you slice it so I don' t think the options you're going to be looking at would include life insurance, bonds, OR equity mutual funds. No, you'll probably be doing the scratch-off retirement plan down at your local 7-eleven.

Comments

[Buff]

Samuel,
There are certainly agents who mislead and sell products that don't fit the situation, but you are making a blanket statement that is just plain emotional and irrational. My father did buy WL 30 years ago and is thanking is lucky stars he has it today.

The first 2 years has no cash value, correct. Think about this long enough and it makes sense when you realize what the company is giving you in return. It is called commitment.

When you borrow money from your own home, you pay interest on it?!?!?! WTF?

If you die, your family only gets the market value of your home, not the equity as well?!?!?! WTF?

You're a bit of an idiot because you're expecting a free lunch.

[Samuel Sweis]

SPOKEN LIKE A TRUE TRASH VALUE AGENT, WHY DIDNT YOU TELL THEM ALMOST ALL OF THE CASH VALUE TYPE LIFE INSURANCE SUCH AS WHOLE LIFE UNIVERSAL LIFE AND VARIABLE LIFE SOLD TODAY KEEPS YOUR MONEY FOR THE FIRST 2-3 YEARS?? WHY DONT YOU TELL THEM YOU EARN ONLY 3-4%?? WHY DIDNT YOU TELL EVERYONE YOU ARE CHARGED TO BORROW YOUR OWN MONEY???? AND AT A RATE OF 6-8%!!!! WHY DIDNT YOU TELL THEM THEY KEEP YOUR CASH VALUE IF YOU DIE??!?!? GET LOST...OH, YOU ALREADY ARE. HOW DO I KNOW THIS??? THIS IS WHAT MY FATHER WAS SOLD, FOR 22 YEARS, AND YOU KNOW WHAT HE GOT OUT OF IT???? A SON WHO IS GOING TO PUT TRASH SELLING AGENTS LIKE YOURSELF OUT, HOW DARE YOU TAKE ADVANTAGE OF OTHERS