Buy term life insurance and invest the savings

Term Life or Whole Life Insurance?

Seed money for a Dividend Farm can come from different sources. It may result from side gigs, pay raises, inheritance, windfalls, or savings from opportunity-cost choices with things like life insurance. How can a decision about life insurance produce seed money? Life insurance is needed to mitigate the risk a family will run out of cash when any of us expire – and we will. Choosing one insurance vehicle or another to mitigate the risk influences availability of savings for investment purposes because of the difference in cost between the two primary options.

   

There are two main types of insurance, term insurance, providing a death benefit only, and whole life insurance that provides a death benefit and may accumulate a cash value over time. Below are three points to consider in the decision about which type to buy:

Premiums:

Whole life insurance premiums can be 10x higher than term life insurance premiums regardless of age or gender. The price comparisons from Good Financial Cents and Nerdwallet offer comparative examples across age, gender, and insurance term.

Returns:

Whole life insurance provides returns of 1.0% to 1.5% for the cash value of the policy with most of that figure occurring late in the policy period. The analyses from Consumer Reports and Investopedia provide detail. However, the short story is that a large portion of your whole life premiums pays commissions and other investment operating expenses instead of death benefits or accruing to you as cash value.

Term life provides zero return because there is no cash value – only a death benefit which is what you need to mitigate risk. Term insurance doesn’t require the commission costs or operational overhead whole life policies do. Consequently, buying term insurance, saving 90% or more on premiums versus whole life insurance, and investing the difference in alternative vehicles may be wise.

Alternatives with reported rates of return as of this writing include:

• U.S. Treasury Bonds:  2% to 2.4% on 20 and 30-year bonds.
• S&P 500: 6.6% for 20 and 30-year historical periods.
• Dividend Champions: Averaging 2.4% with a dividend growth rate of 7.9% over 10 years and increasing dividends 25+ years.

Consider financial options producing returns greater than those of whole life policies when available.

Security:

Whole life insurance proponents claim the cash value is guaranteed while alternative investments are not. The argument sounds logical until you consider the number of insurance carriers that have gone out of business. The probability the United States Treasury or all companies in the S&P 500 Index go out of business at once is approximately zero, but individual insurance companies go out of business more often than thought.

Insurance is necessary to reduce risk. However, Dividend Farmers mitigate risk as efficiently as they can. Whole life insurance is expensive, low performing, and not as secure as sellers claim. Buying term life insurance and investing the premium savings in solid, relatively secure, and better paying alternatives can help you chart a course to a brighter tomorrow.

Thoughts presented are those of the author, who is not a financial professional. Perspectives are not investment advice, but offered for the purpose of discussion and information. For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.