Should I Buy Cash Value or Term Life Insurance
Buying the right life insurance can be tricky. One question we hear a lot is, “should I buy cash value or term life insurance.” Well, the answer depends on your needs.
Your life insurance needs will vary through the many stages of your life, so you will want to make sure you’re not only buying enough life insurance, but also not buying too much. Here are some points to consider:
- How much money will my family need to replace the financial burden of an untimely death (income replacement, college, daycare, final expenses, debt, etc)
- Do you want to gift any money to family, friends, or charities
- Are the financial burdens lifelong needs or temporary; most life insurance needs are temporary, like college fund, daycare debt. Lifelong needs are final expenses, gifting, and advanced tax strategies used in estate planning
- Should you purchase cash value life insurance (whole life or universal life), or term life insurance. We will take a deep dive into this question next
A Deeper Dive Into Cash Value Vs Term Insurance
Before we jump into an analysis between term and cash value life insurance, it may be prudent to establish a basic understanding of the key differences between these insurance types.
Cash value life insurance builds value (cash value over time). This is done by charging you more than the cost of insurance in the earlier years of your policy, allowing it to earn interest (3-5% typically). These policies will also have an expense load of 3-5% of your premium.
In theory, you would have a nice nest egg available to you if you manage to stay upright over the long term, and offer your family a death benefit if you die.
Term Life Insurance does not build cash value or (in most cases do anything fancy). Term life insurance policies will charge you the same amount month after month for the life of the policy (1, 3, 5, 10, 15, 20, 25, 30, or even 40 years). These policies are generally quite affordable, but your coverage will cease at the end ot the term. There is usually an option to convert or renew, but the cost will be exorbitant.
With Term insurance being so affordable and Cash Value life insurance being so costly, many have asked the questions “should I just buy term and invest the difference?”
Lets run the numbers to see if there’s any validity to buying term and investing the difference.
Term Vs Cash Value Life Insurance
The assumptions:
- $250,000 face value
- 38 year old male in relatively perfect health (non-smoker)
- Monthly premium for 20 year level term policy is $15.30, and $114.50 for the universal life policy
- The universal life policy earns 4.65% interest tax free, while the invested difference earns an average of 8%
- The universal life policy also has a premium load of 4.65% (John Hancock Protection UL policy)
In many cases, term wins the debate as to “should I buy cash value or term life insurance”. It wins by a landslide over the long-term. Review the graph below to see the growth of the Universal life insurance policy cash value versus investing the difference in an investment earning 8% annual returns.
At 20 years, the universal life policy has $11,672 while the investment account earned $56,807! Look at the 30 year mark; $166k vs 33k! From a financial perspective, you may ask yourself why would you ever buy a universal life policy; that’s a great question!
Why Buy Universal Life Insurance?
Because you need life insurance coverage to last you a lifetime for final expenses, estate planning and tax purposes, etc. Most people do not have a significant lifelong need for life insurance. Aside from final expenses and gifts to family and charities, most people’s life insurance needs are temporary.
What's the Solution?
Get both, universal and term life insurance policies! A small universal life policy to cover final expenses and an appropriately sized term policy to cover your current and near term financial obligations (mortgage, college for kids, income replacement for spouse). There are some basic guidelines we use to determine the appropriate mix of life insurance, and we have created a handy life insurance needs calculator to make it a little easier for you to figure-out your need. View our Life Insurance Needs Calculator here.
