Life insurance has many tax favored advantages, the most significant of which are the potential tax-free cash accumulation, tax-free withdrawals and tax-free death benefits. In addition, in the event of an untimely death, the beneficiaries can use funds from a life insurance policy to maintain their current lifestyle, for retirement purposes, funeral and burial expenses, probate, estate taxes, daycare, and any number of everyday expenses. Funds can be used to pay for a beneficiary’s education or to pay debts or a mortgage. Recent product innovations include a long term care benefit rider which allows the owner access to policy cash values or death benefit for long term care needs of the insured.
In this article the focus is on death benefit protection. Later articles will focus on cash accumulation and long term care protection.
The question has never been whether or not insurance provides a layer of protection for family and business concerns, but rather, whether or not it is worth the cost?
Some individuals may feel that life insurance protection may only be necessary for a number of years, during which they will accumulate sufficient assets which will exceed the death benefit provided by a permanent life insurance contract. These individuals will generally purchase term insurance for a specified period, because it is currently the least expensive. Faced with the decision of buying term or permanent insurance (which is more expensive in terms of current premium), many financial advisors recommend “buy term and invest the difference.”
In an article by David F. Babel, professor at the Wharton School of the University of Pennsylvania and co-author of “Buy Term and Invest the Difference Revisited,” published in the May 2015 issue of The Journal of Financial Service Professionals, Mr. Babel concluded that the financial analyses which purport to show that the Buy Term and Invest the Difference (BTID) is a better choice are deficient in many ways. He also concluded that the assumed financial discipline necessary to successfully implement the BTID approach is an unrealistic expectation for many consumers. Accordingly, it should not be claimed that one approach is necessarily better for all consumers.
Whether or not “buy term and invest the difference” is ultimately more beneficial depends on some significant variables such as age, health, actually saving the difference, the rate of return on the savings, and the impact of income or capital gain taxes.
Reasons to Purchase Term Insurance:
- Insurance need is temporary
- Need for insurance is permanent, but the insured cannot afford the cost of permanent insurance at the current time. (Note: in this situation “buy term and invest the difference” is not a proper comparison).
- Warehousing insurability
My experience is that buy term, invest the difference is a better choice if:
- The insurance need is temporary
- The insured dies within the term period
- The insured continues to live to life expectancy and the premium savings are actually saved, invested and accumulated for this period of time.
With regard to Number 3, the crossover age (i.e., the age at which “buy term invest the difference” is better) depends on the after-tax investment rate for the savings. By way of example, a male age 50, preferred non-smoker, may purchase a $1,000,000 non-guaranteed universal life insurance policy for an annual premium of around $8,400 per year. The after tax internal rate of return, assuming death at age 88, is 5.21%. A 15-year term policy with the same death benefit will have an annual premium of around $1,600. If the difference in premium is invested at 5.21% (8.02% pre-tax in 35% tax bracket) the investment would have a value of $1,000,000 at age 88.
If you would like more information on this subject, or have a client who might benefit from a discussion about it, please contact Barry Koslow at bkoslow@mkaplanners.com or (781) 939-6050.
Securities offered through Advisory Group Equity Services, Ltd., Member FINRA/SIPC. 444 Washington Street, Woburn, MA 01801 (781) 933-6100.
This article should not be considered as providing accounting, business, financial, investment, legal, tax, or other professional advice or services. It is not a substitute for such professional advice or services, nor should it be used as the basis for any decisions or actions that may affect your business or you personally. This should only be one part of your research. You should seek authoritative guidance from a qualified accountant or attorney before taking any action.
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