Is Term Insurance an Appropriate Substitute for Whole Life Insurance?

In today’s insurance marketplace, level term insurance is everywhere and has been turned into a commodity. In addition, competition has driven the cost down to where healthy individuals can buy large amounts of term insurance for relatively small premiums, certainly much lower than whole life insurance premiums.

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Term Insurance Vs. Whole Life Insurance

In a very real sense, level term insurance is like renting and whole life insurance is like owning. With level term insurance, the premiums are generally the same for a period of years, anywhere from 5-30. After the level period has expired, the policy can often be kept but the premiums often go from hundreds of dollars a year to many thousands of dollars per year. In almost all cases, the level term is dropped at the end of the level period. This is not to say that level term is not a viable insurance plan. It is often, but not always, is the right choice, at least in part. Part of the problem with level term insurance (or any term insurance, for that matter) is that it is bought with the implicit assumption that at the end of the level term period, the insured will not “need” life insurance anymore, and this is a common reason for not pursuing whole life insurance.

That sort of prediction can be financially disastrous. No one can say with certainty that at the end of 20 or 30 years, there will be no need nor want for life insurance. It is not certain that a given individual will have sufficient accumulations in retirement plans, etc. to make the necessity of life insurance non-existent. No one can say that the children will not have special needs, etc. This does not necessarily mean that one should only purchase whole life insurance and not buy term. It simply means that one should think a little more about the wisdom of having no life insurance at a point in time in the future. While most level term policies are convertible to some sort of permanent insurance in the future, the conversion will be based upon the age of the insured when he or she converts the policy. This could mean that the converted policy will be too expensive for the insured to manage at that time.

A possible solution that can make a lot of sense for many individuals is to purchase some whole life insurance and some term life insurance. For instance, someone wanting $1,000,000 of insurance might want to consider purchasing $900,000 of level term and $100,000 of whole life. At the end of the level period (i.e. 20 or 30 years), the term insurance would be basically over. The whole life insurance, on the other hand, could likely be in a position where no more out-of-pocket premiums would be required.

There would be significant benefits to this approach. While it is likely that the need for insurance would diminish in the future, it could certainly be necessary to some extent. Final expenses including attorney’s fees, funerals, etc, and extra support for a spouse are some good reasons to maintain some whole life insurance. In the event that it was not needed, it is highly likely that after 25 or 30 years of having it, the policy could be cashed in and the policyholder would not only get back enough money to cover all premiums he or she paid, but the return on the money deposited in the policy could very satisfactory. Whole life insurance is very competitive with other safe accumulation vehicles like CDs, money markets, etc.

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Everyone seriously contemplating permanent insurance and who is being advised that term is the only answer and that they won’t “need” insurance in the future should ask their advisors (and much more importantly, themselves) a question.

The question is: How do they know?

The media keeps telling you that you won’t need insurance in the future after the children are grown and the mortgage is paid (Which mortgage? The one you have now? What about the one you might start at age 50?). How do they know? How does anyone know if your spouse or child might need or greatly benefit from your whole life insurance policy many years from now?

If you are to really plan, then you need to try to consider how you might feel about having (or not having) certain things in the future.

Assume that you are now a healthy male and are 35 years old. You decide you need $500,000 of insurance and everyone is telling you to buy term insurance. And again, they explain that in 35 years, you will not “need” or want insurance. However, you decide that neither they nor you can predict the future so you decide to get $400,000 of 30-year level term and $100,000 of whole life insurance. You spend about $950 more for the $100,000 of whole life than the equivalent amount of term will cost. But you also conclude that not all of your money needs to be accumulating in vehicles that contain significant risk and there is no harm in having a tortoise or two among the hares in your “financial race” towards retirement.

So now assume it is 35 years later. Your level term is gone but you are not. The only insurance you have is the $100,000 of whole life you bought when you were 35. The nice thing is that perhaps you found that the dividends were able to allow you to stop making out-of-pocket premiums almost 20 years ago. Even so, you still put about $12,000 more in premiums into the whole life insurance than you would have paid had you opted for the additional $100,000 of term and not bought the whole life. So for paying that extra $12,000 (admittedly faster), your total outlay was around $18,000 over 16 or so years you now see that you have a policy that has a cash value of over $70,000; you never paid a nickel of income tax on your $52,000 of gain, a death benefit of over $120,000, you still do not have to pay premiums and yet the cash value and death benefit continue to grow, and you are 70 years old.

If you want to leave it to a loved one or something you care about (i.e. a charity) the death benefit will go straight to your beneficiary at your passing with no probate or income tax consequences. The cash value is quite safe, even from most creditors (in many states). You could cash the policy in (taxes then due on the gain at ordinary rates) or draw an income stream on a tax-favorable basis from it and still have a lot of income tax-free proceeds to leave to a loved one, etc.

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