by Rich Wesselt, founder and principal, Wesselt Capital Group
What is the difference between whole and term life insurance?
You probably are familiar with “term” life insurance, even if you don’t know the name. This model is the most familiar and commonly purchased type of policy. Yet as I’ve discussed before, whole life insurance—while a more expensive upfront investment—is a more financially sound and efficient plan.
This is not the end of the discussion, however. Investing properly in life insurance is critical for retirement planning, so it is important to understand why a term life insurance plan doesn’t completely support a sound retirement plan.
Retirement financial planning
One common retirement planning strategy is “buy term and invest the difference.” This entails buying an inexpensive term life insurance plan and then investing what was saved in not purchasing a whole life insurance plan. One of the theories behind this plan is this: by the time the term policy expires (when the average person is in their late 50s to 60s) they will have accumulated enough wealth that they won’t need to purchase a new plan.
This often is not the case. According to a study by Boston College, 50 percent of households are at risk of significant shifts in their standard of living during retirement due to a lack of savings. Given the massive term life insurance rate hikes that occur past the age of 50, the average yearly rate for a non-smoking man with a 20-year term plan with a $500,000 policy at that age is around $1,077 per year, up from $420 a year at age 40. This can leave people with depleted savings or without a life insurance plan at all. This does not even account for developing health issues between term plans, which results in ballooned rates.
As we’ll see, buying term and investing the difference introduces unnecessary risks and creates a far less diverse retirement portfolio. With whole life insurance, we can offer myriad retirement planning options that allow for secure income.
Case study in millennial financial planning
For those who can afford to utilize the buy term and invest the difference strategy, it’s important to recognize that, on average, it ends up less lucrative than a whole life insurance plan integrated with retirement planning.
Wade Pfau, author and professor of retirement income at The American College of Financial Services, and Michael Finke, chief academic officer at The American College, explained this in their white paper, “Integrating Whole Life Insurance into a Retirement Income Plan.”
Pfau and Finke outlined a scenario with a 35-year-old married couple with two children. The husband, Steve, wants to purchase a plan with a death benefit of $400,000 dollars. He has $50,000 saved in his 401(k) plan under an equity glide path strategy and is planning on setting aside $18,500 a year from his salary for life insurance and 401(k). His options are a 30-year term policy, costing $539 annually, or a whole life policy costing $5,996 annually.
Under the term plan, Steve buys the policy and invests the difference. The whole life insurance plan, on the other hand, is divided into four scenarios, which vary based on how he allocates his assets and investment strategies.
Pfau and Finke found that Steve had greater total income by the age of 65 in each of the whole life scenarios compared with the term scenario, and by a fairly large margin (with the minimum being a 30 percent increase). They also found that the four whole life insurance plans had greater combined 401(k) and cash value balances, and at the median and 10 percent levels, they had far greater discounted lifetime spending power.
This data, among others, demonstrates the lack of reward from buying term insurance and investing the difference. The gain from investing the difference often does not outweigh the needed capital to purchase a new plan, which can leave families in precarious situations. This is especially dangerous when accounting for new illnesses and health conditions that hike up life insurance rates. Additionally, the financial reward from the added investments does not appear to be that significant.
Pfau and Finke’s study demonstrates that combining whole life insurance with a retirement income plan results in greater financial security and well-being on average. Investing in whole life insurance and combining it with your retirement income is an important step toward lifetime financial security for your family.
About Richard Wesselt, Principal and Founder of Wesselt Capital Group
With over 23 years of dedication to the financial services industry, Richard Wesselt brings a wealth of knowledge and experience in helping clients plan for a secure future with financial and investment planning. As principal of the Wesselt Capital Group, Rich uses a relationship driven, individual-based approach to macro economic planning. Rich has a bachelor’s degree in Economics from the Wharton School and is a member of Top of the Table. He holds his FINRA Series 6 Registration. Follow him on Twitter @RichWesselt.