Sunday, September 27, 2009

Buy Term and Invest The Difference?

There are consumers and financial planners who believe that buying term and investing the difference is the best way to buy insurance. For this particular crowd, I have a few more recommendations that fit with this strategy. Here are some other ways to save money and invest the difference. A Honda Civic instead of an Acura, Top Ramen instead of a sirloin steak, a bus ticket instead of airfare, an economical minivan instead of a luxury SUV, reading at the library instead of purchasing new books, and don't forget about brewing your own coffee instead of a trip to Starbucks.

As you can see, there are many ways to save money. However, when it comes purchasing life insurance I suggest you stick to the old adage: cheaper isn't always better. In fact, when it comes to buying term insurance, you'll be surprised to learn it's actually the most expensive option when looked at from a long-term perspective as the cost to renew coverage rises to unaffordable levels as you get older. Most people will assume that you don't need life insurance as you grow older and especially if you've "invested the difference". This is a common fallacy though. Don't forget that when it comes to buying term and investing the difference, human behavior will often get in the way. Rather than investing the difference, the greater amount of cash at hand will most likely go towards a new car payment, a dishwasher, vacation, or more dinners out. If the difference does happen to be invested, it can be prone to stock market loss, capital gains, and/or income taxes which drastically reduces the rate of return. For a real life example, check your 401k statements from the past year. Now imagine Uncle Sam taking an additional 25%-33% if you had to withdraw money for income! OUCH!!! And if you live in the great state of California like I do, don't forget about your state income tax of 9.3% of any income over $44,000! (Are you starting to understand why more than half the money you earn goes toward paying taxes and interest? Learn more at

When you're analyzing the right type of insurance, it is important to buy the type of insurance that is appropriate for your future needs. If income from life insurance for survivors is truly a long-term (i.e., lifetime) need, the lowest net cost insurance, and the most stable investment, is permanent cash-value life insurance. Cash-value that builds in a permanent policy grows tax-deferred and withdrawals to the basis of premium dollars paid into the policy as well as policy loans are tax-free. This makes permanent life insurance a safe and alternative way to build a tax-free, long-term savings vehicle that plays a vital role in developing a successful financial plan.

Most people think of life insurance solely for it's death benefit. You may also be surprised to learn that a permanent cash-value policy provides living benefits in the form of tax-free withdrawals and tax-free policy loans at any age. This type of flexibility cannot be duplicated with any other financial product other than a Roth IRA (which allows for tax-free withdrawals after age 59.5). However, with a Roth IRA, you are limited in the annual amount you can contribute and as your income increases, you may become ineligible to contribute. Furthermore, most investments within a Roth IRA tend to be speculative (stocks, mutual funds, bonds) which have no protection against stock market loss. In comparison, cash-value policies except for variable universal policies, bear no market risk and is secured by the legal reserves of the life insurance company. To be fair, there are no home runs like with the stock market. However, slow and steady combined with tax-favored treatment can provide similar returns when adjusted for taxes and inflation compared to a diversified portfolio of securities, but with none of the stock market risk. I bet you can sleep safer at night knowing your money is protected, right?

Finally, the vast majority of death claims paid are those where the policy was permanent and the insured was older than 65. Since a term policy is designed to protect for a specific period of time of life, there is no guarantee a death benefit will be paid. In fact, the likelihood of a term policy paying a death benefit is minuscule. The percentage of term policies that pay a death benefit range from 3-7% whereas permanent life insurance pays a death benefit 100% of the time when kept to maturity. For my family, I like those odds.

If it is your goal to build long-term wealth that you can enjoy while still living and guarantee to leave a legacy to your loved ones, it is recommended you compare the true costs of term vs. permanent insurance and decide what is best for you. It is my opinion term life insurance is best utilized to protect a family on a tight budget and/or to satisfy a short-term need for protection of 15 years or less.

For more information on the type of coverage that best suits your needs or for an audit of your existing life insurance policy, email or call (800)208-6141.

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