If you’re an advisor, you’ve heard the phrase, “buy term and invest the difference (BTID).” This typical advice refers to buying term insurance and then investing the cost difference (from a whole life insurance policy). So is this advice really best for your clients? Let’s look into the myth…
Why the Confusion?
Let’s get this out of the way first: there is nothing wrong with having term insurance. In fact, having some term insurance in place is a great way for young families to be fully insured within their price range. However, there are a few caveats.
One major concern with term life insurance is the policy doesn’t carry any benefits unless the person dies. Hence, it’s not until death that the policy benefits start, and statistically term insurance rarely pays out. That’s because insurance companies designed term insurance to be for people aged about 30-60, where mortality rates are lowest.
Of course, not cashing out on your insurance is cause for celebration–don’t get us wrong. However, whole life insurance provides living benefits that term insurance just doesn’t have.
“Buy Term and Invest” is Misleading
They myth of “buy term and invest the rest” is misleading to clients, because the strategy assumes that investments will outperform the stock market every time. Term seems especially attractive in this scenario, too, because the premiums are lower. This makes clients feel like they are getting more bang for their buck. However, these are the wrong conclusions to draw.
Most commonly, we hear investors talking about 12% returns in the market. Yet the average returns don’t reflect actual stock market returns. For example, say a client invests $100,000 in one year, and makes a 100% return in the first year. Now, they have $200,000. In the second year, however, the market drops and they lose 50%, bringing them back to their initial investment. They’re left with the same amount they started with, yet they had an average return of 50%. The actual definition of risk is the likelihood of loss, not the potential for gain. Whole life insurance offers certainty—certainty that you’ll never lose money, and you’re guaranteed to see an increase.
Yet, setting aside the discussion of risk for a moment, consider how many people will actually invest the extra money. The promise of “the same product for cheaper” becomes a license to spend more money, rather than to grow that money. While the extra money in the pocket seems like a plus, term insurance is pure cost (because it offers no benefit if it expires). Whole life insurance is a different product altogether and has a higher premium because it is guaranteed to pay out and offers living benefits.
Is Whole Life Better?
When educating about whole life insurance, stress to your clients that it’s not simply a death benefit. It has benefits the person can use now if they want to, such as the cash value. This cash value is liquid, safe, and guaranteed to grow. Premiums for whole life insurance are higher to cover the costs, because the policy is guaranteed to pay out. Term insurance is cheap because it rarely pays out and has no other components, so the insurance companies don’t have to factor in those costs.
Another reason “buy term” is not always the best choice is because with this type of strategy, making a major investment requires a large amount of money. For the best market performance, a person will probably have to save their money first so they can make a sizeable investment later. Realistically, if we reworded it, the phrase might say “buy term and put the difference into savings.” And yet, there’s another even better option to explore.
“Buy Term and Then Save Into a Whole Life Policy”
While this phrase doesn’t sound as catchy, it offers much better results for your clients. Perhaps they’re starting out and want to start with term insurance. Suggest that they take the extra money from the lower premiums and apply it toward a whole life insurance policy. Because whole life is secure and has a cash value that compounds, this is a more permanent solution they can strive to reach.
Term insurance gives them basic coverage at a lower cost and they can then take the difference and apply it to a whole life insurance policy with a low face value. The strategy here is to provide the client with full coverage and the best insurance option that meets their present and future desires.
Now, your client has a permanent policy in place. Despite having a low face value, they can increase their coverage over time. They also benefit from having affordable payments, a win-win. Having the second policy also covers where to save the cash difference from the term insurance. And this is important. Because the person isn’t spending the money, they’re applying it to a whole life policy with a cash value. That means they’ll have safe, liquid savings that out-earn a typical savings account.
If possible, the client can also use a regular savings account to help pay premiums, if they already have money saved up. Then they can access this account while building up their whole life policy too, before it hits the “break even” point.
What About a Policy Loan?
A typical question a client might have is, “What happens if I want to take out a loan against the cash value?” If they want to access the cash that’s accumulated, they’ll take out what’s called a policy loan. This type of loan includes an interest rate and they have the freedom to create their own repayment schedule. The concern we often hear is, “Why would I pay interest on my own money?”
If a client borrows against their whole life insurance policy, the cash value remains untouched. It continues to grow because you’re borrowing from the company rather then pulling funds directly from the account. This feature allows your money to continue compounding at a faster rate. Clients must understand this crucial policy difference, as it gives them the ability to leverage their own money for opportunities and emergencies. They can tap into the money they want, and their policy still earns interest off of the full account value.
Additionally, a policy loan requires no reasoning. If an emergency or opportunity arises, you can access a loan, no questions asked. On the other hand, if you could only go to the bank, you’d have a rigorous application process in order to secure the loan.
Term versus whole life insurance is never an either/or discussion, as they both have their benefits and drawbacks. Even if a client can’t afford their full human life value now, they can start a basic policy with a lower face value. That’s not to say that term is bad. On the contrary, this is just one way to start a policy (with a supplement) your clients can use now.
Work with your client to create a strategy that fits their cash flow and their desires. When it comes to personal finance and financial advising, “buy term and invest the rest” isn’t the most viable strategy. Hence, finding a wealth-protecting strategy can give your clients access to liquidity when they need it. You’re also giving them better options that protect them and their family should something unexpected occur now, or later.