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Term vs. Whole Life

We have been storied from all sides on the “Term vs. Whole Life “ debate in the Life Insurance world. We hear from financial entertainers to financial advisors and every guru, including our neighbors, on the great debate. They profess to tell us which is best, Term or Whole Life Insurance.

But I am not going to do that. Nope, I don’t buy the either/or arguments.

I am here to propose the preposterous.

These are different financial instruments that do different jobs and the best instrument is the one that does the job you want it to.

There, I said it.

Yes, they are both life insurance, but they are different financial instruments with different attributes.

So when you are wondering, which is best for you, I would propose you reverse engineer the answer.

Start with why you want life insurance… what is its job?

If the job is income replacement and debt payoff for your family (for example if you are 30, you may get a 30 year term to cover the risk to your family because by the time your 60, you will have paid off the mortgage and have savings and retirement assets… well that is the goal anyway), then you say OK, let’s give my family some runway if I die- 10 years of my income and payoff the mortgage and other debts. $100K X 10 years = $1Million + $250 Mortgage + $50k cars and credit cards. Totaling $1,300,000. Then a Term policy will cover that risk for 10, 20 or 30 years depending on the applicants’ age. This instrument serves “Income Replacement”, a basic function of life insurance. This is called a “needs” based analysis.

The is also the “Human Life Value” analysis. This is everything your would have earned in your entire life.

If the job is inheritance, then you want to leave something for a spouse, children, a charitable cause or church. A term policy might do the job IF you die conveniently during the term. But if you want to ensure your beneficiaries receive their inheritance (Think ahead- if your spouse has a guaranteed tax free life insurance policy paying off after you pass away, so you can spend down ALL of your assets together and have a longer, more enjoyable retirement knowing that your spouse will be able to go on after you pass.), then Whole Life will do that even if you live to 120 years old. This instrument serves “Estate Planning” function, another basic function of life insurance.

Perhaps you are young and healthy, but you have some student debt and the job is protecting your cosigner. After all, you don’t want your mom and dad or grandma and grandpa on the hook for your student loans. So as soon as you are gainfully employed, you take out an inexpensive term policy to cover the risk for 10 or 20 years until you get those debts paid off. This instrument serves the “Risk Transference” function of life insurance and one of the basic functions of life insurance, Education.

What is old is new again. What if the job is insuring your Long Term Care risk and the risk that you outlive your retirement savings?

Outliving your retirement savings is one of the biggest topics on the financial circuit these days… just Google it. These are two separate, but intertwined risks. If you need Long Term Care, which could draw down your retirement, and/or you could live too long and out live your money.

While the Long Term Care marketplace has gone through upheaval in recent years, Google that too, one solution has emerged from the chaos. Long Term Care RIDERS on Whole Life Policies.

LTC riders on Whole Life policies can let you access the difference between the cash value and the death benefit.

This really is the Holy Grail in protecting your financial life because you get cash for an emergency that is not tied to the stock market (non-correlated) and you take the Long Term Care risk off the table. This allows you to manage the spend-down of your other assets for retirement. This falls under both Retirement and Estate planning, again two basic functions of Life Insurance.

There are a million examples and those are only four. Two best served by Whole Life and two best served by Term life insurance.

The first question you need to ask yourself when you are thinking about life insurance is “what is it going to be used for?”
There is a section on Life Insurance applications that you state the purpose of the insurance. These are approved uses of Life Insurance. (No, you can’t take out a policy on just anyone for just any reason. You have to have an “insurable interest” on the person and have a qualified purpose or use for the Life Insurance.)

Standard Personal uses include:

• Charitable Planning
• Estate Planning
• Wealth Accumulation
• Family Income
• Retirement
• Education
• Mortgage

Standard Business uses include:
• Key Person
• Buy/Sell agreements
• Executive Bonus
• Deferred Compensation
• Split Dollar
• Collateral for Debt

There is an “other” section as well, but if you think about it, it will probably fall into one of the previous standard categories. Just like our example of the Term policy to cover your student loans that protects your cosigners is Education related.

Now for the fun one… This is the purpose that gets everyone all twisted up. Wealth Accumulation. This is the purpose that has financial advisors up in arms and Insurance advisors break out their illustrations.

Let me say something else preposterous. Life Insurance is not an investment.

It is a contract between two parties with value and consideration… and therefore an asset. So it is not an investment, but it is an asset. You can pledge this asset to a bank to guarantee a loan, such as an SBA loan to start a business. As a matter of fact, they require it.

It can be a very valuable asset and that is why the wealthy, banks and big corporations have been buying life insurance by the bucket loads for generations. Life insurance was here before the tax code; I am told by the old timers in the office that is why it is tax free to the beneficiaries. Either way, the benefits of life insurance are manifold.

… And the fact that Life Insurance is not an investment is a good thing. Sure, you can analyze it like a financial advisor and say “oh, the returns are low, you can get better in the stock market.”

Yes, but the stock market doesn’t guarantee anything. The stock market can also take away from you.

Think of your life insurance as diversification for your portfolio. You would be derisking your overall asset base and put a strong foundation of guarantees under your portfolio.

Now you can sleep better at night knowing that the risks in your portfolio are supported by guarantees.

With a policy as described above, a whole life cash value with long term care rider, you would have an asset with cash value for any purpose, a cash flow stream for doctors and the nursing home if you need long term care and an inheritance for your spouse, children, charitable cause or church!

What other financial instrument can do that for you guaranteed? None. Yes, life insurance can be a valuable asset in your portfolio. What it really allows you to do is manage the spend-down of your other assets because you have a few important things guaranteed by an insurance company.

So ask yourself, what do you think… “Should I have all my eggs in one market basket, or should I have a few of my eggs protected?”

So no, life insurance is not the best performing investment so to speak, for wealth accumulation, it guarantees a few important things allowing you to manage your overall wealth accumulation better.

Now, let’s look at the Education purpose through a different lens.

Last time, we wanted to be sure mom and dad and/or grandma and gramps were not on the hook for our student loans.

This time, let’s see if mom and dad and/or grandma and gramps can help pay for college so our little Einstein or Einstein-ette doesn’t need to start out life as a debt slave to a bank.

What if you could borrow out of your own endowment fund? Of course you would want to pay yourself back… but what a difference writing a $400 a month check to myself instead of a bank that will chase me down if I miss a payment? Yeah, pay myself back would be way cooler.

This time, instead of a term policy, we start with whole life permanent policy as soon as our little prince or princess is born. But don’t kick yourself, get one now. I did not learn of this use for life insurance until my daughter was 6, so that is when we started my daughter’s first endowment fund (she has 2). We need whole life because we are looking for guaranteed cash values and no certain time.

Then other reason you want to start as soon as possible is to save their insurability. Over 50% of kids these days have some sort of chronic condition. Google it, I saw 55%… but what ever the number, once you have a condition, life insurance gets more expensive or you just can’t get it at all.

Also, let’s do a 20-pay so mom/dad or grandma/gramps don’t have to pay forever. (Yes, you can do that with whole life too, set a specific period you will pay, then it is paid up and in-force with no more premiums due. With a term policy, the contract expires with no value at the end of the period instead of being “paid up” like a whole life policy)

As an example, my daughter’s 20-pay whole life contract is for $189 bucks a month. I pay this every month for 20 years and stop.

She will have about $45,000 in her college years… and if she pays herself back, she will have over $150k in her endowment fund in her 40’s for a down payment on a house or start a business… and she pays herself back and she will have over $250k in her 60’s for retirement or long term care. This is just the guarantee, add in the dividends and the numbers get better.

And when she finally passes, the remainder will pass tax-free to her heirs. Essentially, I am leaving an inheritance to my children’s children. That’s Biblical.

As life insurance, it is also a protected asset. In Texas, if I get my pants sued off, they can’t touch the endowment fund. I can assign it to my daughter at anytime I choose. It is a pre-marital asset if I assign it to her before she gets married, so it won’t get caught up in any nasty divorce business if that comes up in my daughters’ life. Let’s say she has a rocky start and I don’t assign it to her until she gets older and settles down… then I can assign it into a trust and still have marital protection.

There is no stronger asset available at any cost that you could do for your children. A lifetime emergency fund that is legally protected. That’s why I bought two.

Term contracts are different than whole life contracts and some things can only be done with whole life and some things can be done much less expensive with term contracts. So again, it is not “which is better, term or whole life?” the question is “what is its purpose?”

This next section is for business owners or people who want to be business owners. This is an abbreviated version of business purpose to get some ideas started for you.

Key person life insurance is for the business itself. If a star salesman, genius engineer, pastor of the church or CEO were to die, it would have a significant impact on the business or church. Key person life insurance pays the company or church if the key employee dies so the company can keep the ball rolling in the chaos, then find, hire and train and give runway to achieve what the key employee was doing with out detrimental impact to the business‘ bottom line.

This is frequently done with term life. Some larger companies and banks opt for whole life as that has cash values for the balance sheet. Life insurance cash values are considered “Tier 1 Capital” at a bank… the same as holding a US treasury bond which is also Tier 1 Capital.

Buy/Sell life insurance is for partners in a company. (Whether in an LLC or partnership entity structure.) They have a buy/sell agreement that is funded with life insurance. If one dies, then the other partner(s) get the beneficiary settlement to buy out the partner that died estate. It is a straightforward concept, but it can get complicated. A good insurance advisor can recommend a good attorney to draft your buy/sell.

If a small business does not have a buy/sell funded by inexpensive term life insurance, then those businesses typically fail. Either they take out a personal or business loan to buy out the other party and they fail under the weight of the debt or they just can’t come up with the money and the business is liquidated at fire sale prices and all the partners lose, living and dead.

Also, plan ahead. Let’s say you put the valuation at $500k. Get a policy for $1M and you could pledge the other $500k to get a loan or line of credit from a bank to expand the business or provide operating capital.

Executive Bonus, Deferred Compensation and Split Dollar all refer to employee compensation programs that are “advanced planning” and not in the purview of this article. However, I mention them to keep you thinking about “purpose”. These can be done pre-tax, after-tax, spit and in some cases structured in qualified plans.

So after you start with why- your purpose… add time frame and budget for the life insurance. This will help you decide Term or Whole Life.

If the purpose has a date certain, such as, “I have a 20 year student loan” or a “I have a 30 year mortgage loan”. Then you can manage that risk with a term policy that matches your timeframe.

If the purpose is a time un-certain, such as “I may or may not need Long Term Care, but I don’t want to end up in a Medicaid bed if I do”, then you need a Whole Life type permanent policy that will be there with you to the end and beyond.

Budget and cash flow are paramount in insurance planning. Always stay in budget. It is better to alter the policy contract design then set yourself up for failure by going over budget.

So now, instead of “Term or Whole Life?” ask yourself:

• “What is the purpose?”

• “How long is it for?”

• “What is my budget?”

The answers to these questions will allow you to reverse-engineer the appropriate policy structure.

Quick example; purpose is income replacement… how long? 20 years, until I reach retirement and my income producing years would end anyways. Budget: $125 a month.

Let’s say Mr. Example does the math and he comes up with $2.5 million in income over the next 20 years at $125k per year. At Mr. Examples’ age, $125 will get him $1M. Stay in your budget. Better to get $1 Million that you can comfortably pay then stretch and end up quitting and having no protection at all.

Purpose, How long and budget. Let these answers drive your life insurance planning so we can reverse engineer the perfect policy contract design for your needs.

Book an application appointment online and we can talk about your Purpose, How Long and Budget and design the perfect policy while we complete your application over the phone.