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Encyclopedia > Buy term and invest the difference
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Buying term and investing the difference is a concept involving term life insurance and investment strategies that provide individuals an alternative to permanent life insurance. Generally speaking term insurance premiums are considerably less expensive in the short term than permanent life insurance for an individual for the same benefit amount. Permanent programs are more expensive because they typically combine some form of cash accumulation with the insurance program as a single package. Consumers making use of the "buy term invest the difference" concept, separate their investments from their insurance by setting aside money every month equal to the premium that a permanent plan would require, then use a portion of this money for the term premium and place the rest in a tax-deferred investment vehicle. Image File history File links Unbalanced_scales. ... Term life insurance is the original form of life insurance and is considered to be pure insurance protection because it builds no cash value. ... Invest redirects here. ... The examples and perspective in this article or section may not represent a worldwide view. ...

Contents


Cases for and against implementing the strategy

The advantage of this strategy, if implemented correctly, are obviation of insurance, immediate accumulation of investment moneys, more investment options that allow for similar tax advantages, and return of cash accumulation. Other advantages include elimination of loans and stability in the death benefit.


Obviate the need for permanent insurance

Pros

This viewpoint assumes consumers want to self insure and will eventually be able to obviate the need for permanent insurance. They believe the responsibilities for which they purchase life insurance are temporary in nature and eventually resolve. For example, consumers purchase life insurance to pay off their mortgage, consumer debts, provide education for dependants, and create cash reserves that replace the income of the breadwinner (this is called creating an instant estate) in the event of the insured's death. All of these responsibilities can be resolved as the insured pays off their mortgage and consumer debts, their children become independent, and they develop cash reserves with which to retire. When the consumer has cash reserves large enough, they may self insure (assuming they prefer $100,000 of cash to $100,000 of insurance). Insurance terms may be a number of years in length (10, 20 or 30 year terms) which in theory should provide significant time for the insured to invest and eliminate these responsibilities and self insure. To meet Wikipedias quality standards, this article or section may require cleanup. ...


In the event these responsibilities are not eliminated at the end of the term, many insurers will allow the insured to renew their current policy (guaranteed renewal) or purchase a new policy (conversion) without being subject to the same qualifications, or underwriting, as a new insured. The cumulative costs of renewing term insurance, however, can eventually cost much more than the cumulative cost of purchasing permanent life insurance once. Term polices can be renewed 1 year at a time (annual renewable term); however the cumulative cost of insurance increases substantially making it difficult to use with this strategy.


Cons

First of all, "Self Insure" is a misnomer, since a financial loss is not indemnified. Anyone adopting this strategy is simply retaining the risk and, ultimately, would be willing to accept a loss. Those inclined to this way of thinking must intend to obviate their need for life insurance. If they are not disciplined enought to invest, pay off their debts, or assist their dependants in becoming independent, they still have a need for insurance. For individuals with additional responsibilities or an indefinite responsibility, this strategy would not be beneficial.


Term and Permanent Insurance both exist because a need for both exists. When selecting the proper type of insurance, it is necessary to take into account needs, wants, goals and means. Those who lean toward the "Buy Term and Invest The Difference" way of thinking are often looking at blanket solution to all financial problems related to life insurance and are not focused on everything that can be achieved by the use of life insurance.


Immediate accumulation of investment moneys

Pros

Permanent or whole life insurance (life insurance that typically provides a death benefit for the lifetime of an insured person, or insured, up to age 100) policies usually direct a portion of the premium payment to a sub-account within the policy, called cash value and the other portion to insurance. There are many different permanent life insurance products available with a range of options involving the cash value of the policy, including the ability to withdraw the cash value, loan against it, and to allow it to be drawn on to pay the insurance portion without additional premium payments. Ultimately, most permanent life insurance policies are combination of term insurance with a savings vehicle. Insurers may break down a policy into 2 components, the term insurance portion (the net amount at risk) and the cash value (the guaranteed amount). The examples and perspective in this article or section may not represent a worldwide view. ... Whole life insurance provides for a set face amount (death benefit), a level premium, and a cash value table included in the policy guaranteed by the company. ...


The cash value in the sub-account can accumulates over the life of the policy depending on the policy, however it is generally never available for the first several years of the program.


Whole life programs cash accumulation in the sub-account is generally $0.00 for the first 2 to 3 years despite a portion of the premium being directed to it. In essences this is a negative return or 100% loss over the first 2 to 3 years.


Universal, Variable or Variable Universal typically have immediate accumulation in the sub-account, but are typically not available for loans and are typically subject to a surrender charges for the first several years of the program (frequently in excess of the accumulation), essentially negating an opportunity for return. Universal Life (UL) is a type of permanent life insurance based on a cash value. ... It has been suggested that Variable universal life Insurance be merged into this article or section. ...


With the concept of buying term instead of permanent insurance, more investments vehicles are available, all of which are independent of the insurance program and remain in control of the insured if the insurance portion is canceled.


Cons

The con again is this approach requires discipline. As with refinancing many consumers that reduce expendatures fail to invest moneys saved, and allow it to be reabsorbed into their budget. This also requires investment knowledge and a willingness to assume investment risk. Investors may not know what [investment] opportunties are low risk or provide significant return there by failing to take advantage of the strategy. Investors that bury their money behind the tool shed obviously have no return on their investment.


Investment options

Pros

This practice leaves the insured open to utilize whatever investment options they see fit, however to take advantage of the tax benefits of permanent programs they should first be understood. Life insurance death benefits are never taxable, and cash value growth on permanent programs are deferred (essentially not taxable) as long as the policy is in force, however if the policy is canceled (because the need for insurance is obviated) any accumulation in excess of premiums paid in is taxable. The only way to avoid these taxes is for the insured to die while the policy is in force (essentially making these moneys unavailable to them). Depending on how the insured structures themselves premiums may be paid with pretax dollars (as a business obligation in a corporation for example), but are most often after tax moneys. Variable plans provide the insured the opportunity to choose the investments, though the investment vehicle is still the life insurance plan.


To attain similar tax advantages, the insured may make investments through a tax deferred vehicles, such as an annuity, variable annuity, IRA, Roth IRA or even 529. Moneys applied to a traditional IRA are pretax dollars while those applied to a Roth IRA are after tax. Both investment vehicles grow tax-deferred, similar to cash accumulation; however money withdrawn from a Roth are not taxed. 529's are educational accounts, and annuities are another form of life insurance account. (see http://www.irs.gov/pub/irs-pdf/p590.pdf http://www.irs.gov/retirement/article/0,,id=136868,00.html) An annuity (from Latin annus, a year), is an investment that provides a defined series of payments in the future in exchange for an up-front sum of money. ... Annuity contracts are offered by organizations and individuals that may accumulate value and take a current value and pay it out over a period of years. ... The acronym IRA may refer to: Irish Republican Army See also List of IRAs Irish Republican Army, the self-proclaimed Army of the Irish Republic that fought the Irish War of Independence against British rule, 1916 - 1921 Irish Republican Army (1922-1969): Originally the Anti-Treaty or Republican side in... A Roth IRA is an individual retirement account (IRA) in the United States. ... For other uses, see number 529. ...


Each program has provisions for accessing moneys invested early as does permanent insurance; however the insurance death benefit is not impacted by accessing it.


Cons

Again this requires the implimenter to research investments and how to best take advantage of them.


Return of Cash Accumulation

Pros

Proponents of by Term invest the difference indicate the greatest advantage of this concept is the return of cash accumulation. All permanent programs are cash surrender life insurance due to the fact that the cash accumulation always goes to the benefit of the insurance company who then uses the cash accumulation to pay a portion of the death benefit (this may vary per program see below). Each permanent program handles treatment of the cash value differently, but in the end the cash accumulation is always surrendered, (even in return of premium programs or universal programs that elect to pay the cash value option as well as the death benefit see below).


To illustrate this consumers may review the loan provisions on their program. The cash accumulation could be drawn out of a permanent program as a loan, to be paid back with interest to the program, however in the event of the insured's death, the death benefit is generally reduced by the amount of the loan, in order to pay this back. If the policy is cancelled, the loan is deducted from the cash accumulation and paid to the insured.


To contrast this with the buy term strategy, the accumulation is in a separate investment owned by the insured. In the event the insured dies while the insurance policy is in force, the beneficiary of the investment receives the investment as well as the death benefit of insurance policy. If the insured dies when the policy is no longer in force, the beneficiary of the investment receives it, but no benefit from the insurance policy (which is in effect the same as canceling a permanent program).


Some permanent programs offer return of premium or an option for receiving the death benefit and cash accumulation. In these programs where the cash accumulation is "paid out" in essence the insurance company creates an additional insurance policy and fee on the cash accumulation. The accumulation insurance benefit and death benefit then pay out as the cash is still surrendered. The insured can attain the same effect by investing this small fee at the same rate as the company in their own account.


Cons

Most tax vehicles have a cap as to the contributions that can be made on an annual basis. Some individuals in some jurisdictions may max out all available programs that can be deferred indefinintly, and only be able to overfund their insurance program, creating a shelter to pass on to their survivors. This shelter is also resistant to penalties brought from lawsuits. Again investment knowledge is required, and this is of benefit only if the insured intends to cancel their policy or reach the age of 100 (when they are considered statistically dead and the policy pays out).


Other

Because of the increased premium at attained (then current) age, additional consideration should be given renewal or conversion of term insurance at the end of the original term. Also, purchasing annual renewable term insurance can add complexity to long-term investment strategies because premiums increase as the insured ages.


The basic forms of permanent insurance include:

  • Simple whole life insurance is essentially decreasing benefit term insurance, as the net amount at risk decreases at the same rate as cash value accumulates. Eventually, the cash value equals the benefit amount.
  • Universal life insurance is a form of whole life insurance in which, at a certain point, the cash value may be used to pay premiums and keep the policy active, or in force.
  • Variable life insurance and variable universal life insurance are permanent insurances in which some or all of the cash value in the sub-account may be invested in mutual funds, money markets, bonds, cash or other investment strategies.

Whole life insurance provides for a set face amount (death benefit), a level premium, and a cash value table included in the policy guaranteed by the company. ... Universal Life (UL) is a type of permanent life insurance based on a cash value. ... It has been suggested that Variable universal life Insurance be merged into this article or section. ...

External links


  Results from FactBites:
 
Buy term and invest the difference - Wikipedia, the free encyclopedia (1857 words)
Buying term and investing the difference is a concept involving term life insurance and investment strategies that provide individuals an alternative to permanent life insurance.
Insurance terms may be a number of years in length (10, 20 or 30 year terms) which in theory should provide significant time for the insured to invest and eliminate these responsibilities and self insure.
Term polices can be renewed 1 year at a time (annual renewable term), however the cumulative cost of insurance increases substantially making it difficult to use with this strategy.
Term life insurance - Wikipedia, the free encyclopedia (1136 words)
Term life insurance is the original form of life insurance and is considered to be pure insurance protection because it builds no cash value.
Buy term and invest the difference is a concept that grants the insured unlimited flexibility in investing their money and should be used in combinations with the Theory of Decreasing responsibility.
Term offers coverage will pay a death benefit which is usually income tax free, as long as the policy is in force and premiums are current (Death benefits of both Term and Permanent coverage are usually income tax free).
  More results at FactBites »

 
 

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