Buy Term Invest The Rest vs Whole life (Explaining The Numbers)
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Whenever it comes to life insurance, the most common question that clients would ask is the question: “Which is better for me? Buy term invest the rest or a whole-life plan?”
This is a very good question. I can certainly understand the need to know the difference as it is quite a huge decision to be made.
In this video, I would like to walk you through the numbers behind these two strategies so that you can have a better understanding of the quantitative behaviour of each of these strategies.
Hopefully, by the end of this video, you can decide which strategy are you more comfortable with.
Without further ado let’s get started
What is BTIR and the 2 types of approaches?
Before we delve into this topic, let me just take some time to explain what Buy Term Invest the Rest is and what are the 2 different approaches available.
Now buy-term-invest-the-rest is a strategy where you spend a fraction of your budget on term insurance and invest the differences instead of spending the entire budget on whole-life insurance.
The common understanding is that if we were to invest the differences instead of utilizing the entire budget on whole-life insurance, we will be better off as the returns from the buy-term-invest-the rest approach will be higher than the returns from whole-life insurance.
Having said that, there are two ways in which you can construct a buy-term-invest-the-rest portfolio.
The first is an apple-to-apple replacement where you design your term insurance in a way that mimics the exact behaviour of whole life insurance that covers you for your life.
The second is the more common approach of BTIR where you design your term insurance in a way that just covers you for a pre-determined period and beyond that, there is no coverage.
Each of these approaches will have a very different cost, coverage and portfolio value behaviour which is what we will be looking at next.
Parameters for comparison
To facilitate this analysis, here are the parameters that were used for this comparison.
In terms of the cash value behaviour of the whole-life plan, I’ve taken an average of both the values based on an estimate of 3% and 4.25% investment return.
By doing so, we are being realistic instead of being too optimistic or pessimistic when it comes to the expected returns of your whole life insurance policy.
With that out of the way here are the findings.
Findings on Pay-out Receivable
For starters, let us take a look at how much will we receive in an event of a claim. For context, the total payout receivable would be the sum of the insurance coverage receivable PLUS the estimated investment value.
By applying a return of 2.5%, for both approaches, a term life plan would provide a higher payout receivable before the coverage expires or step down at 70 years old. Beyond 70, a whole-life plan would provide a higher payout receivable.
By applying a return of 4%, approach 1 shares the same finding as to the previous behaviour while for approach 2, term life would yield a slightly higher payout receivable throughout the entire duration.
By applying a return of 6%, approach 1 provides very similar payout behaviour between the term and whole-life plan while for approach 2, term life would yield a higher payout receivable throughout the entire duration.
Findings on Surrender Value
The next thing we will look at is the surrender value. For context, the surrender value would be the sum of the estimated cash value of the insurance policy AND the estimated investment value.
By applying a return of 2.5%, for approach 1, a whole-life plan will provide a higher surrender value throughout the entire duration while for approach 2 a term life plan would provide a higher surrender value before the age of 55. From 55 years old onwards, a whole-life plan would provide a higher surrender value.
By applying a return of 4%, for approach 1, a whole-life plan will provide a higher surrender value throughout the entire duration while for approach 2 the term life would provide a slightly higher surrender value throughout the entire duration.
By applying a return of 6%, approach 1 provides a similar surrender value behaviour between the term and whole-life plan while for approach 2, term life would yield a higher payout receivable throughout the entire duration.
Summary of findings:
All things considered, this is the summary of the findings for both the behaviour of the payout receivable in an event of a claim and also the behaviour of the surrender value for both approaches.
For approach one, unless your return rate is higher than 6% per year, a whole-life plan will be quantitatively better than a BTIR.
For approach 2, which is the more common one, BTIR will be quantitatively better than a whole-life plan if you can achieve a return of 4% per year.
Additional considerations & personal stance
Despite being fully capable of earning a return of more than 6% per year, I would still prefer to use a whole-life plan to act as the foundation of my insurance portfolio and provide for my long term coverage needs.
The reason for saying so is because:
1) to achieve a 4-6% return a year, I will need to take on additional risk that, chances are, is higher than the risk of the return of a whole-life plan. From a risk-adjusted standpoint, I believe that a whole-life insurance plan would make more sense.
2) I prefer to keep my insurance and investments separate in a sense whereby the efficacy of my insurance strategy is not reliant on my investment performances.
The reason why I say this is because, in theory, earning 4,6,8 or even 10% a year seems very doable. In practice, it is not as easy as it seems to be because of discipline and emotional factors that may impede your performance.
By keeping my insurance and investment separate, it will not impact the quality of my decision-making process during tough times because the last thing you want for yourself is the constant thought that if your investments fail to perform both your insurance and investment strategy would have been compromised.
At the end of the day, I think what matters the most is that you understand what the benefits and risks of a buy-term-invest-the rest approach and a whole-life insurance approach are before you commit to either one.
You should also take into consideration, how your decision in your insurance planning would affect other areas of your financial planning such as investment, children education and retirement planning.
Do take into consideration of qualitative factors as well as to determine which strategy will be more suitable to you from a holistic financial planning approach.
Daniel is a Licensed Independent Financial Consultant with MAS and a certified Associate Wealth Planner that provides:
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This article is meant to be the opinion of the author
This article is for information purposes only
This article should not be seen as financial advice
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