Permanent life insurance (sometimes referred to as whole life insurance) offers much better value for life insurance buyers who can afford to pay higher premiums and capitalize on its better net cost. Comparing the net cost of permanent life insurance to the net cost of term insurance is the true measure of determining which type of life insurance costs less. The net cost is the total premiums paid minus the total cash value. For example, if $80,000 of premium was paid into a policy over 10 years and the cash value of the policy now has $100,000, the net cost would be a net gain of $20,000. The longer you own a permanent life insurance policy, the better its net cost will be. With net cost, a lower number is better and a net gain means the policy has more cash value than premiums paid in. The longer you own term insurance, the worse the net cost will be. Therefore, switching from term insurance to permanent insurance is a necessary step in optimal life insurance planning. Incidentally, there are only two types of life insurance – permanent insurance and term life insurance. Whole life, universal life, variable life, 20 year term, 30 year term and survivorship are all types of permanent or term.
What is the difference between term insurance and permanent life insurance?
Permanent life insurance provides lifetime coverage. Or, it can be designed to provide coverage to a predetermined point, selected by the policy owner, not the insurance company. Some permanent life insurance policies build up equity or cash value, some do not. The out of pocket cost of permanent coverage is more than the out of pocket cost of term insurance in the early years. As a result of lower premiums for term in the early years, many people may believe that term insurance is “better”. Since the definition of better is not the lowest price, a meaningful disconnect is established and it catches many people off guard.
Permanent life insurance is far better value for lifetime coverage.
Term insurance expires at the end of 10 years, 15 years or as long as it’s guaranteed. How long does permanent insurance stay inforce? The simple answer is that a permanent policy will remain inforce for as long as the policyowner wants to keep it. Term insurance is the ideal name for temporary coverage because it lapses at the end of the stated term. It was never intended to compete with permanent coverage. Permanent insurance puts the policyowner in control of when the coverage ends, not the insurance company. Term life insurance is a bit like musical chairs. The music goes faster and faster in musical chairs, just like increasing term premiums do as you get older. When a term policy expires, you may find yourself without coverage or good options when you need them most.
“Too many people have been sold a theory called “buy term and invest the rest”. They were told they could invest better than insurance companies. The theory was to invest, each year, the difference between a term premium and the higher premium for permanent coverage. This amount would be invested, accumulated and used to pay for escalating term premiums when the term policy expired, later in life. Buy term and invest the difference has proven to be a costly mistake. For example, if the annual difference between a term policy and a permanent policy is $7000 per year for 20 years, people were told to invest the $7000 in a side fund that would accumulate and pay future premiums. This marketing gimmick suggested that insurance buyers could grow a side fund faster and better than insurance companies who pay commissions and apply surrender charges in the early years.
It sounded like a reasonable plan to many, unsuspecting and unknowing people. Unfortunately, it proved to be nothing more than a deceptive parlor trick. “Buy term and invest the rest” was primarily promoted through entry level multi-level marketing groups. The projections are often run using interest rates as high as 7% to grow the side fund. Someone who bought a 20 year term policy in 2005 may have seen projections using 7% while the real interest rate over that period was 2% or less.
Compare that to insurance companies that invest billions better than individuals with small amounts. Insurance companies employ the best and brightest to work in their investment departments. Insurance companies watch their investments 24/7 while policyholders run their lives, including their families, businesses, social lives and time away. There are no taxes paid while the insurance company is managing the asset. Many people never invested the annual difference between the term premium and the permanent premium. Of the few who did, most of them did not invest with discipline. If they skipped years or withdrew funds from the side fund account, the whole thing was derailed. Fast forward to today and we have nothing but a messy trail of people with expiring term insurance, different health and no side fund to pay the higher insurance premiums into the future. Some people cannot get new coverage. Most people failed to convert the term they initially bought.
More and more people buy permanent life insurance when it is properly presented to them. “But what about Dave Ramsey and Suze Orman? They don’t like permanent life insurance”. Or do they? What do they own, personally? They are not insurance professionals and they do not offer advice to individuals because that would require them to be in compliance, require licences, proper education and put their reputations on the line. It is easy for pundits to make general claims for which they have no personal responsibility. Term insurance is right for many young families until they have the financial means to upgrade to permanent coverage with much better net cost. They know their audience.
Buying life insurance is a process over a lifetime, not a one-time event. Term insurance can be the right decision for families without coverage. The right time to consider buying permanent insurance is sooner than later, but since that is not always possible, these triggers can lead people to consider upgrading:
When moving from the “paycheck to paycheck” lifestyle, we become potential permanent life insurance buyers. Since ninety seven percent (97%) of all term policies do not pay a claim, then 97 percent of ALL term premium were wasted. High Net Worth (HNW) consumers and high income earners choose permanent life insurance because it has better value:
Replacing Your Income: If your family or business depends on you and your income to run smoothly, permanent life insurance is the right product for those who can handle the higher premiums.
Immediate Liquidity: Very wealthy people own permanent life insurance. They want the guaranteed liquidity it provides at death.
Permanent Life Insurance Is The Best Tool For Mitigating Succession Planning Problems:
- The value of assets fluctuates significantly and death is always the worst time to sell a business or other assets.
- Many people have children working in a family business. Life insurance is the great equalizer for those children who do not work in the business. Without liquidity in these cases, there is great risk to a smooth succession of a family business.
- More and more grandparents own a life insurance policy for each of their grandchildren. The insurance policy is straightforward, inexpensive and a “feel good” asset knowing how it will impact the grandchildren.
- Premium Financing. Wealthy people have the ability to finance life insurance. When it makes sense, it is a very effective tool to create tax free wealth.
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Also published on Medium.