There is a big debate going on about life insurance, should you buy whole life or go for term life and invest the rest instead. The good news is, you can find out for yourself.

How? By using the Prosperity Planner tool to look at the benefits of both schemes, compare them, and decide which one to go for.

I illustrate hereunder how Prosperity’s financial planning tool can be used to understand your needs, to identify the benefits of life insurance and to choose the best life insurance plan. You will see, life insurance plans can make a very large difference on your wealth, and your loved ones.

What’s in a name: term life and whole life insurance

Here is a generic explanation between term life and whole life:

“When choosing between a whole life or term policy, you need to consider two key factors - your budget and level of protection need. If you can live with a lower level of coverage and wish to get your premiums and some bonuses back at the end of the policy term, then a whole life plan would meet your requirement. If you can spare only $100 a month but require a high level of coverage in order to take care of your dependents, then a term plan may serve this need better.
If you plan to use a traditional whole life policy as a protection cum savings plan, term insurance can also be a good alternative. The savings that you derive from buying a term plan could be used to invest in funds that would yield potentially higher returns over the long term, compared to the yearly bonus that you may receive from a traditional life plan.”

Right, but that still does not give me some hard figures to base my decision upon. I want to see some numbers, with real life examples and calculations.

To be able to compare term life and whole life, we need to look at the entire life savings plan, not just insurance coverage. The reason behind this is that a life insurance protects a family from the death of the breadwinner, but if the breadwinner accumulated a strong portfolio of invested assets, the family is safe. Hence, insurance protection and accumulated wealth are interlinked, and we need to look at both.

In order to compare different plans, we need to set up a portfolio that is growing over time until retirement, and how the wealth is going to behave during retirement. This has to be done side by side with the insurance coverage provided by both plans, and then we can compare both to be able to make an informed decision. The impact on your wealth can be dramatic.

Whole life insurance: your wealth and insurance coverage

After having browsed to the Prosperity Planner, I start by filling in my portfolio in the financial snapshot module. I also include a whole life insurance plan as given in the figure below. The insurance covers me for a total value of $500,000 for a monthly premium of $800. This is quite a large premium, but the coverage is substantial. The settings of the Life Insurance are given in the figure below.

Once my financial situation registered in the Financial Snapshot, I have an overview of my assets, liabilities, income and expenses. The income and expenses now let me understand better how much savings I have per month, part of which I can invest in my portfolio for my retirement plan.

Using the Wealth Manager module, I look at my retirement plan and I see that I need to invest $500 per month to have a sustainable plan that provides me with a buffer of $200,000 at the age of 85. I feel comfortable with that. However, if I could have more during retirement, I would be happy to, but my savings rate does not allow me to invest much more than $500 per month. The figure below shows my financial plan, from today until the age of 85.

 

Let’s have a look at the insurance coverage that this life insurance provides me. As stated in the Financial Snapshot, the life insurance covers me for $500,000, and if something unfortunate happens to me, that is what my dependents will get as a pay-out from the insurance company. However, I have also to take into account the wealth that I accumulated since this will be included in my legacy to my dependents. Hence, the number of years my dependents can survive is comprised of the life insurance pay-out as well as the wealth accumulated.

The figure below shows how long my dependents can survive based on some assumptions on my dependents’ needs. If I die at the age of 40, my legacy will enable them to carry on without any additional income for 15 years. After that, the cash is negative, showing a shortfall in case my dependents need more coverage.

As an additional example, if I die at the age of 65, the following figure shows that my dependents will be able to benefit from my life insurance coverage as well as the wealth accumulated which will give them a larger protection. Indeed, the wealth accumulated will be larger when I will be 65. The protection provided is more than 20 years, as shown below.

Term life insurance: Comparing your wealth and insurance coverage

Now that I did the exercise for a whole life insurance plan, let’s have a look at what term life can do for me. The settings in the Financial Snapshot are all the same, except for the life insurance policy which is now a term life. The premium is substantially lower, which results in much larger savings compared to purchasing a whole life policy. I now only pay $80 per month, which is one tenth of a whole life policy. The term insurance has a maturity at the age of 65, which means that if I die after I am 65 years old, the policy will not give any pay-out. If I die before that age, the term insurance will give my dependents a pay-out of $500,000, the same as the whole life insurance as described above. The settings are shown in the figure below.

My wealth accumulation plan will look very different, since I can invest much more in my portfolio. I am now saving $720 additional dollars per month. If I invest this additional amount on top of the original $500, my retirement looks completely different as shown in the financial plan below, the net worth I have at the age of 85 is now $2.4 million compared to $200,000 ! 

Let’s not get carried away for the moment, we still have to see what the insurance coverage looks like with a term insurance. All settings remaining the same, if I die at the age of 40, my dependents have now a legacy as shown in the figure below, 17 years of coverage for the term life compared to 15 years of coverage with the whole life. Why is that? The insurance pay-out is the same ($500,000), but the accumulated wealth passed on to my dependents is larger since I could invest more money in my portfolio…. An important difference that is often overlooked!

But what about the protection if I die after I am 65 years old? Since the term insurance does not cover life any more after the age of 65, it is important to look at how my dependents will be protected. Keeping the same parameters as in the whole life insurance simulation, the results show that the wealth accumulated and left for my dependents is actually larger than with a whole life insurance plan, even when there is no pay-out from the insurance company. This is because the wealth accumulated is much larger than the wealth and insurance pay-out under a whole life plan!

This is quite an astonishing outcome, and a very valuable one. The common statement ‘Buy term and invest the rest’ is indeed true in this case, however, it might be different for you, try it out for yourself!