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  • Writer's pictureThomas Hayes

Whole Life Insurance vs. Term Life Insurance and a Diversified Portfolio

Updated: Jun 27, 2023

I always tell clients to be aware of the incentives life insurance agents may have to sell you certain policies. You don’t want to get stuck with an expensive cash value policy that isn’t right for you. Let’s break down two types of insurance policies, and then look at a scenario that compares whole life insurance to term insurance, with the premium differential invested in a diversified portfolio.

Term insurance functions as pure insurance coverage. You pay a certain amount in premiums each year, and in exchange, the insurance company agrees to pay your beneficiaries a set amount of money if you die while the policy is active, known as the death benefit. These policies often involve a rate lock feature, where the annual cost is set for a certain number of years. At the end of this period, you can choose to renew at higher rates, or let the coverage lapse. This is the cheapest, most straight forward form of life insurance.

Whole life insurance functions as life insurance coverage with a cash value component. You pay a set premium each year until age 65, a portion of which goes to the policy’s cash value component, and you receive coverage for your entire lifetime. The cash value component is generally credited a set rate of interest each year, and can be withdrawn from the policy, or taken as loan, which generally will reduce the amount of the death benefit. Whole life, like it sounds, is coverage for your whole life, regardless of when you pass away.

Now let’s imagine we have a 35-year-old male that needs $500,000 in life insurance coverage for at least 30 years. Let’s also assume they are a healthy, non-smoker, who qualifies for the preferred health class. The cost of a term policy, with a $500,000 death benefit and the annual cost locked for 30 years, is roughly $477.93 per year depending on the carrier. If this same individual were looking to get whole life insurance coverage, the average cost would be roughly $6,852, according to data from Policy Genius.[1]

Obviously the cost difference here is significant, so in this scenario imagine the individual intends to purchase the cheaper term insurance, with the rate locked in at $477.93 per year for 30 years. Then, they plan to take the approximately $531 per month difference in premium cost, and invest it in a portfolio tracking the S&P 500.

Where do they stand after 30 years? After 30 years the death benefit on the term policy would lapse, leaving them without coverage for the remainder of their life. However, their investment portfolio, assuming historical average returns of the S&P since 1957 of 10.15%[2], would be worth $1,078,377.02. Resulting in a total net gain of $872,879.12 after $14,337.90 in premiums paid and $191,160 invested. This also assumes the funds have remained invested during this period, and as a result have avoided capital gains taxes. However, even if the individual had paid the top capital gains rate of 20% on their investment returns each year, bringing total annual returns down to just 8.12%, their portfolio would still be worth $727,923.06, with a net gain of $522,425.16 after premiums paid and principal invested.[3]

Now let’s look at the results had they purchased the whole life insurance policy. They would have paid premiums of $205,560 to have the entire policy paid in full after 30 years. Assuming they were to die the following year, their beneficiaries would receive the $500,000 death benefit, and their total net gain on the policy would be $294,440 after premiums paid.

The difference is clear in this case. The term policy paired with an index fund investment, would net an additional $227,985.16 in total gains, even assuming the gains were taxed at the highest capital gains rate on an annual basis. With the investment portfolio left in an index fund unsold, deferring capital gains taxes, the difference could be as high as $578,439.12. Also, assuming the individual holding the term insurance policy had passed away within the initial 30-year time span, they would still have received the $500,000 death benefit from the term policy, just as they would have for the whole insurance policy, in addition to being able to pass along the investment portfolio to their heirs with a step up in cost basis.

There are specific estate planning scenarios where whole life insurance may make sense, so be sure to speak with an estate planning attorney, licensed insurance agent, and financial advisor about your specific circumstances before making any decisions. However, term life insurance may make more sense for individuals in the family formation phase, and potentially provide additional long-term upside in terms of total return, at a significantly lower cost than whole life insurance.

PLEASE NOTE: The information being provided is strictly as a courtesy. When you link to any of the web sites included, we make no representation as to the completeness or accuracy of information provided at these web sites. The opinions found therein are those of the author(s) of the article or website.

The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

This article is intended to assist in educating you about insurance generally and not to provide personal service. They may not take into account your personal characteristics such as budget, assets, risk tolerance, family situation or activities which may affect the type of insurance that would be right for you. In addition, state insurance laws and insurance underwriting rules may affect available coverage and its costs. Guarantees are based on the claims paying ability of the issuing company. If you need more information or would like personal advice you should consult an insurance professional.

[1] [2] [3] This does not account for potential investment management fees, but includes taxes taken as stated in the example. Returns are stated in current dollars, and not inflation adjusted terms for both term and whole life examples.

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