Buy term and invest the difference is something that you have probably heard before, or perhaps it has even been offered to you by a friend or colleague. But what exactly is this concept? Is it even a smart investment option?
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A Short Definition:
Buying term and invest the difference means you will use an amount equivalent to what it will cost to purchase a permanent life insurance plan, and then compare this to the expense of a term policy for a similar face amount covering the time period it is required. In the following example, whole life policy will be used as an example of a permanent life insurance.
It will show you how term insurance is less costly compared to whole life insurance, so what you do is take that difference and invest it somewhere else. In other words, you’re going to settle for a cheaper term insurance policy and invest money that you would otherwise spend on a whole life policy. This can be a great investment plan for the senior citizens who are willing to purchase life coverage today.
How the Policy of Investing the Difference Works:
If you’re a non-smoking, 40 year old American in relatively good health, a $250,000 whole life insurance policy should cost around $347 monthly. In 20 years’ time the cash value guaranteed is about $70,000, but factoring in the present values, that can be raised to a little over $105,000.
That sounds good, but compare it with the cost of a $250,000 term policy which runs for 20 years. Employing the parameters mentioned above, the monthly due will start at $23: that’s a difference of $324 monthly, and if you invest the $324 you save every month for 20 years with an annual return of 8%, the total will be $190,800, give or take a few dollars.
This is just an example of how this policy not only saves you money, but also helps you make money down the line. Rather than spend the money paying for insurance premiums, you can simply invest the cash in a retirement account, and if the contribution has been maxed you can save it in a non-qualified investment account.
Better Returns in the Long Run?
For those who haven’t done any investing before, it might seem a bit frightening given the daily fluctuations in the stock market. There’s no question there’s volatility in the market but this is usually in the short term, and if your investment horizon is for the long term (15 to 20 years), you can expect good returns.
The benefits of getting term policy and investing the difference is still better even if you factor in the taxes. There are a lot of different tax brackets true, but if you crunch the numbers and compare the results it’s clear that tax savings cannot compensate for the lower yields that a whole life insurance policy offers when ranged against equities. Indeed, there’s no guarantee when positive returns will emerge from a whole life insurance policy, as it could come up on the 10th year.
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Whole Life and Term Policy Compared:
To illustrate the difference in investing the difference insurance and whole life insurance, consider a scenario where a healthy 35 year old male invests in a 30 year term policy with a $400 premium, and another 35 year old male invests in a whole life insurance with a premium costing $4000 annually.
Under this scenario, the difference between the two policies is $3600, and the man with the term policy invests the amount in a retirement account or another investment fund. Using the figures quoted above, the 35 year old man that invested in the $4,000 premium whole life insurance policy will earn 4.77%, whereas the term policy investment returns on average, 10%.
The example above shows how much of a difference it makes if you invest the difference in premium. Under the scenario outlined, the $3600 is placed in a retirement account and grows tax deferred. Even assuming that the investment is a non-qualified account, the term insurance will still provide higher returns.
Here, the 35 year old man who purchased the 30 year term policy is going to own a life insurance until he reaches the age of 65, the usual retirement age.
Where to Invest?
All of the information has made it clear that it makes more financial sense to buy an inexpensive term insurance rather than on a whole life insurance policy. Whether you’re looking at the short term or long term, whole life policy doesn’t provide as much benefits, but the key here is to invest wisely. So, lets find out some investment opportunities for buy term invest the difference method.
This is important:
There are a lot of options available such as bonds, stocks and mutual funds, and you have to research each one and take into account your risk tolerance and what your long term goals will be. Keep in mind that these assets provide different returns and market conditions vary, and the time you redeem is going to be important.
Some people will tell you that there are a lot of risks involved with investing, but that’s true only if you don’t plan ahead. Furthermore, there are investment instruments for those who are averse to risk, such as Certificates of Deposit (CDs). These are covered by the FDIC and pay a fixed interest rate regardless of what happens to the economy.
But if you’re willing to deal with short term volatility, you can put your money in the equities market and as the examples given show, the potential returns are much higher. Rather than spend all that money on insurance premium, it’s better to invest it and make more by the time you reach your retirement age, which is the ultimate goal.
If you want to buy term and invest the difference, you can take advantage of the free insurance quotes we offer here.