This post is by Brian Poncelet, an insurance specialist and independent certified financial planner (CFP) who has been working in the financial services industry since 1994.
For years some financial experts have suggested the most cost effective way to protect your family is to buy term life insurance and invest the difference. For the average Canadian who earns $46,000 per year this strategy probably makes sense. However, if you have a yearly salary of $100,000 or more you should seriously consider supplementing your term coverage with whole life insurance. The benefits are many – not only will you be able to spend your hard-earned money freely, you’ll pay lower taxes with lower risk for loved ones and yourself. Let’s walk through an example.
At first glance good friends Allen and Bob are very similar. Both are 35 year old males and breadwinners of families with a solid annual incomes of $100,000. Both have similar insurance needs – they have a wife and child to provide for and protect. This is where the similarities end – Allen and Bob select totally different insurance strategies.
Allen: Buys Term and Invests the Difference
Allen thinks short-term and buys a $500,000 term 20 policy at $42.75 per month. Allen intends to drop the coverage at age 55 since the rate renews for a whopping $572.40 per month. He has $1,000 cash to invest every month for the next 30 years. Assuming he achieves a rate of return of 7% he ends up with $1,227,087 at age 65.
Bob: Buys Term with the “Forced Savings” of Whole Life Insurance
Bob also buys a $500,000 term 20 policy at $42.75 per month. However, Bob wants to own a permanent whole policy which he pays $400 per month for 20 years. This policy starts at a death benefit of $180,000 with no cash value. With his $400 being spent on whole life, Bob only has $600 left to invest each month for the next 20 years.
Who comes out ahead at age 65?
Based on Allen and Bob’s plans above you might think Allen who invests $1,000 per month might have more net worth than Bob. Remember, Bob is only investing $600 per month for 20 years and $1,000 per month for 10 years. However, when you do the math (and this is what a professional insurance agent can help you with) Bob comes out ahead in death benefit coverage but also overall net worth. If Bob passed away at age 65, his family would receive $1,280,803 ($788,889 from his investment portfolio and $491,914 death benefit).
Not only would Bob’s family receive $53,716 more than Allen’s family (who no longer has insurance coverage by the way) Bob’s family would pay at least $100,000 less in taxes and fees! Check out some fees as an example for administering an estate.
|Allen – Term Life Policy||Bob – Term + “Forced Savings”|
|Coverage||$500,000 term 20 year policy||$500,000 term 20 year policy;Whole life policy starting at $180,000|
|Premiums||$42.75/month||$42.75/month (term);$400/month (whole life)|
|Investment||$1,000/monthfor 30 years @ 7%||$600/month for 20 years and $1,000/month for 10 years @ 7%|
|Net Worth@ Age 65||$1,227,087||$788,889|
|Death Benefit @ Age 65||$0||$491,914|
|Total Net Worth||$1,227,087||$1,280,803|
OK, I know what you’re thinking: 7% was a realistic rate of return a decade ago but times have changed. What about a 5% rate of return? Allen will have a portfolio worth $1,220,000 while Bob will have a portfolio worth $1,288,000 ($788,000 portfolio plus $500,000 death benefit).
Does term and invest the difference always sound like the better choice now?
Nobody hopes to pass away at age 65 but it’s nice to know your family is financially protected in the worst case scenario. Hopefully you think twice next time you hear phrase “buy term and invest the difference.” With the right combination of term and whole life a person can come out ahead with less risk and you can spend your hard-earned money more freely.
Brian Poncelet is an insurance specialist and independent certified financial planner (CFP) who has been working in the financial services industry since 1994. Along with insurance, Brian Poncelet focuses on mortgage and retirement planning. Check out www.rightinsurance.ca for more information.
My Own Advisor: I’m sure this post might be a bit controversial to some readers. What’s your point of view – comment away!