The “buy term and invest the difference” strategy became popular a few years ago in some circles as a way to save money on life insurance premiums while still investing for the future. The idea behind the strategy is simple: instead of buying a whole life insurance policy that includes both a death benefit and a cash value component, individuals buy a term life insurance policy with a lower premium and invest the difference in the stock market or real estate.

While this strategy may seem like a smart financial move for some, it’s not without its weaknesses. It is important that individuals and families be aware of the drawbacks of using a “buy term and invest the difference” strategy for financial planning and be open to alternative strategies which are more likely to yield better results in the long run.

Working closely with a financial planner who can tailor a strategy that fits your needs and financial habits is the best way to get the best results.

Now let’s explore some of the weaknesses of “buy term and invest the difference” and present some alternatives that could be better for you.

The cost of liquidity

When you “buy term and invest the difference” you end up with most of your money in market correlated assets like stocks, bonds and real estate.  While these have historically performed well when held long term, the returns you make on them can be eaten up by capital gains taxes, fees and even penalties if you try to remove that money in the short term.  What’s more, when you remove your money from an equity position in an investment, there is no chance to benefit from any future growth in that investment.  

Alternatively, when you opt to take money out of a whole life insurance product, you do so tax free.  In fact, you don’t actually take the amount of money out of the product, you instead take out a loan against the cash value.  The advantage of this is that the money remains in the policy and continues to grow at a guaranteed rate of interest in your policy.  You can also still receive dividend payments from your insurance company which you can opt to get added to the cash value.

Because you can use your policy loan money for anything you want, many people who are savvy with their money, use it to invest in real estate or the stock market — earning a guaranteed tax free rate while also potentially making capital gains on the same dollar.

Guaranteed return on investment

One of the biggest weaknesses of the “buy term and invest the difference” strategy is that with the vast majority of term policies you lose every dollar of premium paid while the returns from your investments are not guaranteed. While an investment account may yield a higher return than the cash value component of a whole life insurance policy, there is no guarantee that the investments will perform as expected. This means that individuals may end up with a smaller nest egg than anticipated or even lose money on their investments.

The key to solid retirement planning is to take advantage of the potentially higher yields of the stock market or real estate market — which we call market “correlated assets”, and also get guaranteed income from whole life insurance products and annuities — which we call “uncorrelated assets”.  These uncorrelated assets, backed by hundred-plus-year-old insurance companies, have paid out through the Great Depression, the World Wars, the Real Estate Bubble of 2008 and every other down market, making it the perfect hedge against the ups and downs of the market. 

It’s worth saying at this point that not all term insurance policies are created equal.  With some insurance carriers, there is a way to use your term product as a form of savings product.  Using what is called the “return of premium rider” on specific term life insurance products will allow you to be paid back some or all of your premium payments if you do not die during the term.

“[You can use your cash value policy loan] to invest in real estate or the stock market — earning a guaranteed tax free rate while also potentially making capital gains on the same dollar.”

Discipline is required

In order for the “buy term and invest the difference” strategy to work, individuals must be disciplined enough to consistently invest the difference between the term life insurance premium and the whole life insurance premium. This requires a level of financial responsibility that not everyone may be able to maintain over the long term.

Limited protection

Finally, it’s important to remember that term life insurance policies only provide protection for a limited period of time. Once the term expires, individuals may need to purchase a new policy at a higher premium rate.  They may even lose their option to have life insurance coverage altogether if their health has gotten worse by the end of the term and they have become uninsurable. This could leave your loved ones vulnerable in the event of your eventual death.  In fact, less than 3% of term insurance ever pays a death benefit, leaving 97% of those who “buy term” without a tax free death benefit to leave behind as a legacy to build generational wealth.

Professional Financial Planning

While the “buy term and invest the difference” strategy may be an attractive option for those looking to save money on life insurance premiums and invest for the future, it’s important to carefully consider the potential drawbacks before committing to the strategy. A better option is to use a professional financial planner who can look at your overall financial picture, money habits and financial goals and then tailor a strategy that optimizes the way you save and invest. As part of that strategy, your financial planner may recommend term life insurance, whole life insurance or indexed universal life insurance based on your specific needs. When choosing a financial planner, be wary of those who use a one-size fits all strategy or who only represent a narrow range of products. You want a planner who is versed in multiple strategies and represents a wide range of financial products.

Reach out today for your strategy

Find out which strategy can be tailored to help you accomplish your financial goals. My role in the process is to analyze your current financial situation, consider your future goals and help you to decide what type of life insurance product would be right for you. Reach out to me via my contact form or by phone (305) 613-1498 to learn how you might be able to benefit from life insurance as a component in your financial plan.