Are you looking to buy life insurance to protect your loved ones? Chances are if you are you are looking at the differences between a few policies. The main two types are term and permanent, such as a universal policy for the purposes of this blog. Now I am a licensed life insurance agent in the state of Tennessee; however, I am also finishing a Master’s of Science in Financial Planning so I have a conflicted approach to this particular subject. As a life insurance agent I prefer you would buy the universal life policy from me as the annual premium is higher than that of a term policy thereby allowing me to make more off that sale. As a financial planner I would advise you to buy the term policy and invest the difference between what you are paying for the term policy and what you would have paid for the universal life policy thereby making a smaller commission on the sale due to the fact a term policy can be purchased for a smaller annual premium. As I told you earlier we will compare a universal life policy and a term policy and assume the following conditions. First we are insuring a 42 year old male who is a non-smoker and has no health issues. The policy is for a death benefit of $250,000 as that is about the maximum that an insurance company will issue a policy for without a medical portion to the application process. The term policy will be of two lengths, a 20 year and a 30 year fixed premium. Those two policies will be compared to a universal life policy from the same major insurance company.
Many financial advisors who also appear on national television shows will advise you of the same thing I would and that is buy the term policy and invest the difference of that and a universal life policy would cost. So who is telling you this besides me? Most of you have probably heard of Dave Ramsey or Suze Orman. They advise this approach all the time on television and in their books. Now I have read many books by both of these well-known and respected individuals but I really do not recall them showing me the math behind their advice. Well, I will show you what the numbers look like when you purchase a term policy and invest the difference. Once you see the numbers I think you will agree with the well-known professionals and myself. Now you are most likely asking yourself what is the catch? Well that is simple, you have to be disciplined and actually invest the difference to make this work.
Now had you purchased the universal life policy you would be guaranteed a death benefit of $250,000 for life provided you continued to pay the premiums on the policy. And most insurance agents will try to sell this policy as not only an insurance policy but an investment as it does generate a cash value that you can use to borrow against or pay the premiums in your later years. While it is true that most policies that are considered permanent policies will have a minimum guaranteed return and you generally will not lose any of your principal. About now you are telling yourself this sounds pretty good, I get life insurance and it generates a cash value that I can borrow against. What most agents neglect to tell you is that the guaranteed return is most likely not going to even keep up with inflation and if you do borrow against the cash value you have to repay the loan with interest or it will be deducted from your death benefit. Now is it not sounding quite as good is it? And this final piece of information will seal the deal for you most likely. And that is this policy will cost you $252 a month for the rest of your life and the cash value that is accumulated cannot exceed the death benefit. In most cases where that does occur you get to keep the insurance and not pay the $252 a month while still being insured.
Now let’s say you go with a term policy over the universal life policy. In the example I will put before you we have two choices, a 20 year and a 30 year policy. The good thing about term policies is that if you need additional coverage for 20 years but still want the coverage for 30 you can purchase both at a relatively inexpensive price. While in this example either a 20 or 30 year term policy is purchased it is still affordable to purchase both if you have a need for both. What would cause such a need you ask? Say you just purchased a house with a 30 year mortgage and wanted to ensure the house would be paid for in the event of your death. Simple you buy the 30 year term policy. Now say you have a child and want to ensure they have money for college. Now you would buy the additional 20 year term policy when they were about five years old to cover their college years. Now unlike the universal policy these two policies will end at the end of the term and they accumulate no cash value. If you die they will pay your beneficiary the $250,000 but if you outlive the policy it simply ends and the insurance company keeps your premiums. Now I am sure you are asking what the policy costs if the universal policy was $252 a month. The same death benefit for a 20 year term policy is $46 a month and an extended 30 year policy is $76 a month. Both of those premiums are vastly different from the $252 a month cost of a universal life policy.
First we will look at the difference between the 30 year term and the universal life. Now you were a careful and mindful person who always pays their premiums for the universal life policy. At the end of the 30 years you would have a cash value in the policy of $121,552 at a cost of $90,720. Now had you purchased the term policy you would of course have no cash value but the cost of the term policy would have only been $27,360. If the difference of $176 was invested every month in an indexed fund that gave you a 7.5% return, which is lower than the S&P 500 return for the last 30 years, you would have an account with $237,150 in it. In this case you can afford to have no insurance on your life at all and self-insure as by saving the same $176 a month for an additional ten years would give you an account of $532,193. And depending on how you invested these funds they could be tax free if they were invested in a ROTH IRA. Regardless, buying the term policy and investing the difference is the better option in the end provided you stay true and always pay the premiums and invest the difference. The comparison between the 20 year term and universal is basically the same with a lower cash value and paid premium in the universal life policy and a smaller account balance for the invested term difference.
Now I know you are thinking to yourself that life insurance proceeds are tax free. That is true but if you are worried about your spouse they pay no federal estate taxes on anything you leave them anyway. And in the event it is left to your children provided you, your spouse and the children did some estate planning the proceeds can be tax free if the funds were invest through a ROTH IRA and can continue to grow tax-deferred if the proceeds are placed in an inherited IRA by your children. They will then be required to make minimum annual withdrawals over their lifetime and if there is any money left in the IRA when they die it passes tax free in a lump sum to your grandchildren if there is proper estate planning by your children.
As you can see by the actual numbers I have laid out it is better to buy the term policy and invest the difference of premiums in a ROTH IRA. If you cannot invest in a ROTH IRA due to the income restrictions there is a solution for that as well. Make non-deductible contributions to a Traditional IRA and immediately convert it to a ROTH IRA. By doing that you will have minimal taxes and get the tax free advantages of a ROTH IRA for your spouse, children and possibly grandchildren.
Think about the bottom line after say 40 years. If you purchased the universal life policy you would leave $250,000 your heirs. Had you bought the 30 year term policy and not died for 40 years while always investing the $176 a month you would leave your heirs over half a million dollars. And if done with some estate planning and the use of beneficiaries that half a million would be tax free the same as the life insurance policy.
If you want additional information or have any questions feel free to contact me.
