Whole Life Vs Term- What are the Differences?

Hi, Matt with EWA. Today we are covering one of the most debated topics in financial planning, which is life insurance, and specifically to buy term insurance and invest the difference and at some point self insure or to get a whole life or some kind of permanent life insurance that will last forever.

So just to give the landscape a term insurance is a type of insurance that typically is very inexpensive. You can buy in 1020 or 30 year increments, or some companies will even go all the way until you’re 80 with an increase in premium every year.

But the philosophy here is that you pay a very low cost, let’s say for 20 years. You have a million dollar policy. You’re going to pay pennies on the dollar. If you’re a young, healthy, let’s say, 30 something year old, this is going to be $50 to $60 a month for a million dollars of coverage.

And if you pass, your family gets a million bucks. If you live to the 21st year and all the money you put in there is a use it or lose it proposition, the coverage goes to zero. At that point, you’d have to reapply for a new policy and hope you’re still healthy.

But the philosophy here is that typically your needs boil down to what’s called a life acronym. So you want to cover liabilities, you want to make sure there’s income for a surviving spouse. You want to make sure final expenses are covered and also education costs are covered for your kids if that was a goal to fund while you were living.

So in general, that will work out to be about ten times someone’s income. So if someone’s income is, let’s say, $300,000, then you would need $3 million of life insurance coverage. Again, instead of using the Ten X rule, we really like to do what’s called a needs based analysis to determine the exact amount out.

It can be anywhere between as low as eight, as high as 20 X your income, depending on the kids. Do you want to fund undergrad and postgrad a lot of factors playing into that? So what we find though, is that typically your highest amount of life insurance need will be while your kids are under the roof, but it doesn’t necessarily go to zero.

Even if your kids are in college, typically your late forty s and fifty s are the most important savings years for a lot of people to make sure financial independence is on track. And without life insurance, a surviving spouse may be in trouble.

So then there’s the whole life insurance conversations. The whole life insurance, obviously it lasts your whole life. You put a lot more monetary commitment into it. Typically this would be structured to be paid off by the time you retire.

It has a death benefit that it’s done with a mutual company, with participating dividends that would grow and then also builds a cash value that can be accessed for emergencies that can be withdrawn or surrendered.

Canceling the policy altogether. It could be taken out with a loan. You’d avoid taxes and you’d also avoid the market. Being up or down would be an irrelevant conversation. So it could be a good safety net if structured.

Obviously you need to pay back the interest or the death benefit would pay back the loan for you when you pass. So there’s a line of thinking is what is the better route? Do we do a term and invest the difference route or we do a whole life route?

And there’s some very black or white thinkers out there. So for example, Susie Orman or Dave Ramsey, which they’re not financial advisors or licensed but they’re entertainers, would recommend a zero on a whole life insurance and they would be 100 on a term and invest the difference philosophy.

White coat investors specifically for physicians, he would probably be like a five out of 100. Very few specific examples. He would be okay with the whole life insurance. Again, not an advisor, a doctor.

But a lot of doctors go to him for financial advice, writes a good blog and generally has good content. Then there’s insurance agents that make their living selling whole life insurance. And certain companies have a belief system that every dollar you save should not be in the stock market.

It should be a whole life insurance contract. So some companies or agents would say it’s 100 or all your money. So in general, our philosophy is term and invested difference. Until you have maxed out your 401 you also need to have a Roth IRA maxed out or backdoor roth IRA have a health savings account maxed out.

You should also have 529 plans contributed to properly. Once all of these things are done, if your income is high enough and there’s excess and you also need the protection, then whole life insurance becomes an alternative option of safe money.

Some of the pros to it would be in most states it is asset protected. It provides a death benefit that does not expire. You can have a long term care rider that you can pull from the death benefit tax free and not have to worry about the stock market, what it’s doing or not doing during retirement years.

You can utilize the cash value if the stock market is down just for normal needs during retirement and piggyback that from investments are good or investments are bad. That’s when you decide the next year of where to pull the money from either an investment portfolio or a whole life policy contract.

So I’d say in general, if you’re a high income earner we would kind of fall in the 20. So it’s a good fit for some high income earners assuming certain conditions are met. And then if you’re not a high income earner we would be on a zero or in most cases it’s not appropriate.

In general, this is a very individualized discussion. The principles we follow is first, making sure you have the right amount of life insurance and force first and foremost to protect your family. And then secondly, from a budgetary, assuming those other things are maxed out, the whole life insurance we look at is the cash value.

By 65 going to have a three year, generally recommend to have seven years. So for example, if you need 150 a year of spending Social Security is paying 50 you need a difference of 100,020 years later that’s going to be 200,000.

Because of inflation, we potentially want $600,000 of cash value in that contract by your. Total of seven years of safe money. The other four years would come from bond or cash reserves, but that’s often an effective way to have safe money available for your retirement.

The second thing is we’d want to. Make sure that the death benefit that. Can be pulled from from long term care, there’s enough to pay off half of the anticipated cost. So for a female, the average female stays for almost four years.

In a nursing home, the average male, if needed, would stay for an average of three years. So currently, the tax code cuts off. At 329,000 to go from the 24% rate if you’re married to the 32% rate, and that’s even half if you’re a single payer.

So in a lot of cases, we’ve seen married couples, one person goes, eats away at some assets and passes. Now the surviving spouse has less assets. And also half the tax runway to work with. So where this can really come and be a very tax efficient option to pay for long term care is all the money the death benefit is passed on tax free.

You can withdraw the long term care. Out also tax free, and avoid those high tax surcharges if you’re a widow. Or even if you’re married and in a higher income during retirement. So in general, we believe this has to be looked at very closely.

There’s no one size fits all with insurance. We should do an individual analysis, figure out what your long term needs are. Also, we’re addressing short term needs, and it’s really a balancing act to make sure you have the best insurance program.

That fits your needs, your budget, and. Ultimately make sure your money is working for your life.