The concept of buy term and invest the rest is not new. If it seems alien to you, buy term and invest the rest is a classic financial planning philosophy to tell you not to buy “Whole Life” or “Investment Linked Policies” for one’s life insurance protection needs.
This is because you may be paying too much for coverage and for investments decisions that you do not have control over. As a solution, you can buy a term life insurance for the same coverage at a much lower premium.
Even as a firm advocator of the buy term and invest the rest strategy, in this piece, we will explain some flaws which we have observed as to why this concept may be detrimental to some client’s financial planning.
We will use a simple permutation to compare the premium difference between buying term life insurance vs a whole life insurance that provides equal coverage till the age of 65 and show the cash value for surrendering the whole life insurance right after 65 years old.
|Type||My Whole Life IV||MyProtector Term II|
|Advance Stage CI||200,000||200,000|
|Premium Term||25||34 years|
Cash Value @ 66
Non-Guaranteed @ 3% p.a.
Non-Guaranteed @ 4.25% p.a.
The above comparison between term and whole life is within the same insurer “Singlife with Aviva” for a Term and Whole life insurance with the stated coverage permutation. 1 minor difference between these two is that the early ci benefit for My Protector Term II is additional whereas the early critical illness benefit for My WholeLife plan iv is accelerated. This means upon claim of early ci, the term insurance will not reduce the death benefit but the whole life insurance plan will.
Buying term and investing the rest assumes you will invest the difference in premium between buying the term insurance and whole life insurance for at least the first 25 years. Based on the comparison table above, we will be looking at an investible savings of $2,663.20 each year for the first 25 years. If your investment can yield you a 4.25% p.a. average return, the $2663.20 you save each year would have compounded to about $120,000 on the 25th year! This looks like a much better strategy on face value, however there maybe some setbacks pertaining this strategy
First, you may burn the surplus on something else instead of investing the difference, which defeats the purpose.
Second, you may achieve much poorer investment returns or lose part of your monies or lack the discipline to continue your investment well into the 25th year.
For most Singaporeans, retiring at 65 years old is a given thanks to CPF Life. Buying term and investing the rest assumes that you will not require insurance after retirement or you can self-insure thereafter with the monies saved from investing the difference, IMHO this may be premature thinking.
While it is true that most people will require higher insurance coverage during their active years, many discount the fact that medical conditions and health complications may occur soon after or right before their retirement. The lack of planning to mitigate such risk may create financial shocks as retirees will need to drawdown their retirement war chest to foot medical bills not covered by their health policies. Having a whole life insurance provides the options to maintain your coverage or to cash out during retirement age, if one chooses the former, the pay-out may provide financial cushion against unforeseen medical costs.
Though it seems like term insurance is easier to maintain when it comes to the premium, it will be easier to terminate as well. Over the years, we have seen a higher probability of customers lapsing on their term insurance policies than their whole life insurance policies. This is because customers know that for most term insurance plans, they will not get any cash back in return and will require longer period of payment, these factors act as a financial deterence when they are faced with temporary financial issues. Customers who has bought both term and whole life insurance will be more likely to choose and keep their whole life policies over their term policy during emergency financial situations.
Whole life policy cash value makes it harder to forego even though there may be affordability issue faced by the policy owner. Whole life insurance also has the limited premium payment term feature such that at certain point in time when the situation calls for, client may only have a few more years of premium left to be paid and then they get to keep it for a lifetime.
As such, the whole life insurance portrays a much higher value than term insurance mainly because of the cash value feature of the plan and clients will be more inclined to maintain and pay for it even if there are changes to their financial situation and objectives.
This misconception is the strongest one yet. It is known that most term insurance plan requires you to pay throughout the policy term. This means, if you are looking to get insured till age 65, you will have to pay till 65 years old likewise if you are looking to get insured till 99 you will have to pay till 99 years old.
It is inevitable that memories erode as time passes, the longer since you’ve bought the plan, the harder it is to remember. For example, its easier to remember something a decade ago than two decades ago. Although it is easy to set up recurring payment with any insurers these days with payment facilities such as GIRO arrangements, there can be instances where the customers either forget that they have such policies many years later when they close off their bank account or they simply forgot to have sufficient funds deposited in their bank account to be debited for the next premium payment. Such is the risk when you buy a term insurance policy that will have to be paid for a few decades or for life.
Maybe by 60 or even 70, certain illnesses may undermine your memory and the gift you once known to bequest to your loved ones might have been the worst financial decision you have ever made. A Whole life insurance on the other hand can be structured to defray such circumstances as premium payment term can be as short as single premium or flexible enough to be customized to your preferred term.
Do you agree with our take on the cons of buying term and investing the rest? Consult us and have a discussion regarding your own financial planning needs.