Buy term invest the difference

Be careful -read this before you buy life insurance as a result of this sales strategy.

Buy term invest the difference is a strategy for people who have whole life insurance with cash surrender values. The basics behind the strategy is that you cancel the whole life insurance, take the resulting cash surrender value and invest it, then purchase a term life insurance.

The idea while possibly valid, has some criticisms that are always overlooked with this is pitched. Interest rates shown on the investments are often optimistic to aggressive. Then those investments are compared to a cash value of a whole life – but the cash value of a whole life can be either guaranteed, or at a minimum vested (can’t go negative). Why would you compare growth from one thing that is either guaranteed or vested, against an aggressive non-guaranteed external investment? Because you’re trying to sell term insurance is why :).

This sales strategy is also wildly outdated. In the 80’s when this first came to Canada from the US, the industry had a bad habit of selling whole life insurance, perhaps inappropriately. One particular company that only sold term insurance used/uses this sales strategy to sell their term life insurance.

There’s two reasons this is outdated. First, the industry has moved on – other than a few holdouts, term insurance is far and away the most common life insurance type in Canada. Secondly most companies have far better term life insurance policies (better features) than the companies that are known for pitching the buy term invest the difference.

Does that mean you should buy term and invest the difference? That would take an individual appraisal to determine. But what I can suggest is that if you’re getting pitched this strategy and are thinking of term insurance, that you should shop around. There’s likely to be better, cheaper term policies than what you’re seeing.

Term life insurance vs Whole Life Cash Value

Stop – before you compare term vs whole life, you need to consider a more basic problem.

Before we get the the nuts and bolts, I want to realign your thinking. Comparing these two types of insurance from the perspective of ‘which one should I purchase?’ is misleading. They are two different solutions to two different problems. Term life insurance has premiums that are level for a time period (called the ‘term’), after which point the policy is not really feasible. It’s best suited for people who need life insurance for a timeframe – while the kids are at home, until you retire, etc. Whole life insurance typically has premiums for life. It is therefore more suitable for people looking to keep life insurance forever (well, at least until you pass). You should consider which problem you are solving before deciding what type of insurance you need.

One further note as well. You don’t have to pick one or the other – you can do a bit of both. Common practice is to have a large term policy with a smaller permanent policy. This gives you a large amount of coverage (sum of the two types) while you’re young and earning income. Then you cancel the term insurance in the future and your coverage reduces to just the whole life which sticks around for the rest of your life – i.e. your coverage stays high when you have family dependents and expenses, then drops down around retirement age. This is called layering, and is in fact what I have personally – a layer of permanent life insurance topped up with a much larger (and cheaper) term life policy.

AttributeTerm Life InsuranceCash Value Whole Life Insurance
Premium StructureLevel for a time (10,20, or 30 years), then increases, often 7X.Level for life, or pay higher premiums for a time and then 0 afterwards (quick pay).
Premiums GuaranteesPremiums generally fully guaranteed for the duration of the policy.Often not guaranteed, though some variations exist that are fully guaranteed.
Coverage structureLevel for duration of the policy.Generally level, though in some structures may be increasing over time.
Coverage guaranteesCoverage generally guaranteed level.Coverage (particularly increases) may not be guaranteed.
Cash valuesNope.Yes, cash values are available on policy cancellation.
Coverage LengthEffectively, for the duration of the initial 'term'.Generally for life.
  • Premium Structure. Term life insurance has premiums that increase every ‘term’. So a 10 year term has premiums that are level for 10 years. In year 11 premiums increase (generally by about 7X) and then are level for another 10 years, staircasing up like that until the policy expires. Whole life at it’s core has premiums level for life. Variations exists that can short pay the premiums (pay higher premiums for a shorter period of time, eventually creating a policy with no more premiums.
  • Premium Guarantees. Term life insurance premiums are generally fully guaranteed. Whole life insurance premiums may be, but are often not guaranteed.
  • Coverage Structure. Term life insurance has a death benefit that is level. Whole life insurance has a death benefit that is often level but variations exist that can have an increasing death benefit.
  • Coverage Guarantees. Term life insurance coverage is generally guaranteed not to change. Again whole life coverage is often not guaranteed but variations exist that are guaranteed.
  • Cash values. Term life insurance insurance is close to pure life insurance coverage, there are no cash values – if you cancel the policy there’s no money returned. Whole life has cash surrender values, which are effectively a partial refund of higher premiums. There’s a lot of sales strategies that center around whole life cash values, you should be careful and sceptical if that’s why you’re purchasing life insurance.
  • Coverage Length. This is the fundamental difference between the two types of life insurance. Life insurance has an expiry age, but is really only effective for the initial term. Whole life insurance is lifetime coverage and is expected to be kept for your entire life.

Term Life Insurance vs Universal Life Insurance

Compare and contrast term life insurance to Universal life insurance, but before we do that let me provide an outline of the two different types of policies.

Term life insurance has premiums that are level for a timeperiod (the term) then increase. At a certain age the policy expires. It’s about the purest form of life insurance you can get. No cash values, no investments, no bells and whistles.

Universal life insurance is effectively term life insurance plus an investment side account strapped to the side. There are two basic types of term policies that form the base of universal life insurance policies in Canada – YRT and Level. YRT means yearly renewable term. This type of term insurance has premiums that go up every year. Universal life insurance with ‘level’ term costs means the insurance section of the policy has level life insurance premiums for life. Premiums are not set – you pay whatever premiums you choose. Any premiums above the cost of insurance go into the investments. You should read our other articles on Universal Life insurance that go into how all these things interact.

Nevertheless, perhaps the most important distinction is in the intent of the two types of life insurance. Term life insurance works best for insurance needs with a timeframe that has an end date – even if that end date is 20 or 30 years in the future. Conversely universal life insurance is intended to be permanent life insurance – insurance you keep until you pass no matter how old. Buying term when you need life insurance forever, or buying universal life insurance when you don’t expect to keep it forever, are both nonsensical things.

With that baseline understanding, here’s a table comparing and contrasting attributes of term life insurance vs universal life insurance.

AttributeTerm Life InsuranceUniversal Life Insurance
Duration10, 20 or 30 years.Lifetime.
Premium structureIncreases at the end of the term. Premiums are not defined, instead are variable.
Insurance cost structureThe insurance cost is the premium.The insurance costs can be increasing every year, or level for life. You do not have to pay premiums tied to the insurance cost directly.
GuaranteesPremiums and coverage both guaranteed.Typically premiums and investments not guaranteed.
Investments/cash valueNone, no option.Optional side investment. Any premiums paid above the insurance cost are invested in a tax sheltered environment.
UsesCoverage for a pre-defined number of years. Often used for family coverage.Coverage for lifetime. Often used in complex estate and tax planning situations.

Further explanation of those attributes:

  • Duration. Term insurance is effective for a predefined term – often 10, 20 or 30 years. Universal life would be intended to be kept for life.
  • Premium structure. Term insurance premiums are level for the initial term – the initial 10, 20 or 30 years. After that the premiums increase to the point of being unaffordable. Universal life insurance premiums are variable and have flexibility. It’s possible to pay premiums for life, or front load heavier premiums resulting in a fully paid up policy when you’re older – again, very flexible.
  • Insurance costs structure. This is only worth mentioning because it’s not what you’d expect with universal life insurance. With term insurance, the premiums are the cost structure (which is what you’d expect – you’re paying the insurance costs). With universal life insurance, the costs are distinct from the premiums. YRT cost structure in universal life has insurance costs that increase every year (so you either need to pay those high costs later, or get enough into the investments to pay those costs later) or level for life.
  • Guarantees. Term life insurance is typically fully guaranteed, both premiums and coverage. With Universal life the interactions between the insurance costs, your variable premiums, and the investment portions with non-guaranteed returns, that there is effectively very little about a universal life policy that is guaranteed.
  • Investments/Cash Value. Term life insurance covers strictly insurance. There are no investments or cash values or surrender value. You pay the premiums, you’re covered. You stop paying premiums coverage ends. Just like car insurance. Universal life insurance however has a discrete investment component that you can direct some of your premiums into. A huge benefit of universal life is that those investments are generally tax sheltered – which has a big impact on your long term investment growth. Therefore universal life is often used in tax and estate planning (and less so for life insurance coverage). If you are considering such a strategy you need to have a clear understandings of the investment and insurance risks.
  • Uses. Term insurance works for short term family needs, coverages for loans, and similiar needs that have an eventual end date. Universal life insurance is well suited for permanent lifetime insurance needs and advanced estate and tax planning strategies.

Term Life Insurance vs Group Life Insurance

Having worked extensively with both term life and group life insurance in the past, here’s why you should keep your term insurance and not use group life insurance as a substitute.

First, let me start off with a table comparing attributes.

AttributeTerm Life InsuranceGroup Life Insurance
OwnershipPolicyowner (you).Your employer.
Premium structureGuaranteed level for term (10,20 or even 30 years).Projected level until your next quinquennial age increase (ages 30,35, 40, etc).
Premium guaranteesGuaranteed in the policy.No guarantees, prices could change next year.
ControlYou are in full control of all aspects of the policy.Employer controlled.
ConversionOption to exchange your term to permanent/lifetime coverage.Option to convert only upon cessation of your group life insurance coverage.

Here’s why you care about those attributes:

  • Ownership. You have no control over the ownership of a group policy, it’s controlled by your employer. This means they can cease offering the coverage. They can switch companies to an insurer that has higher premiums. They can reduce benefits. All without consulting you. With an individual term life insurance policy you control all of that.
  • Premium structure. With a group life insurance policy, premiums can increase at unpredictable intervals, by unpredictable amounts. If you start your policy at age 34, your premiums will increase next year at age 35. Individual term life insurance premiums are locked in level for the duration of the ‘term’. You should be careful about comparing premiums between the two types of coverages as group insurance premiums will suffer from increases in the future.
  • Premium guarantees. Pretty much nothing about group life insurance is guaranteed. Rates could change in the future because your employer changed insurance companies. Or they could change just because the insurer had unfavourable experience across their entire customer base. An individual term policy guarantees your premiums for the duration of the term (and normally beyond that for the entire duration of the policy). When you purchase an individual term policy all future premiums are displayed right in the policy, upfront.
  • Control. With group life insurance insurance your employer can decrease available coverage at any time. They also dictate the coverage amount,without regard to your individual needs. And they pick the insurance company. All of these things are outside of your control. With an individual term life insurance policy you control all of that and more.
  • Conversion. You’re group life insurance coverage stays at group life insurance coverage – unchangeable by you. If you lose the coverage (quit, etc) you have 30 days to exchange the group coverage for a pre-defined individual life insurance policy, most likely a whole life. That exchange is only available for 30 days – not before, and not after. With an individual term life insurance policy you can exchange or convert your term to permanent life insruance at any point up to the conversion expiry age. If you become uninsurable you’ll want to exchange to permanent immediately (to lock in your earlier age) rather than waiting until you quit.

Because of all of these factors if you’re comparing term life insurance vs group life insurance you should consider purchasing an individual term policy and treating the group life insurance coverage as non-guaranteed top-up to your coverage.

Term life insurance vs Mortgage Insurance

Don’t buy mortgage life insurance until you read this post!

Before I get into details, let’s set the stage with a video from CBC Marketplace on the subject of Mortgage life insurance. I recently spoke to the agent in this video and he assured me that the content and concerns in the video are as relevant today as they ever were.

Here’s a comparison of attributes of term life insurance and mortgage life insurance:

AttributeTerm Life InsuranceMortgage Life Insurance
UnderwritingFully underwritten at time of applicationPost-claim underwriting
Premium structureLevel for term (10, 20 or 30 years commonly)Level for the term of your mortgage (likely 5 years)
ConversionYes, exchange for a permanent life insurance policy if you become uninsurable.No. If you become uninsurable there are no exchange optoins.
Coverage structureLevel.Declines with your mortgage balance.
BeneficiaryYou choose, often naming spouse or other family.Your favourite bank.

Why do you care about these attributes?

  • Underwriting. This can increase your probability of having a claim denied. With mortgage life insurance they do post-claim underwriting; they don’t look at your information until you make a claim. If there’s something they don’t like that could result in a claim denial they won’t find it until your beneficiaries make a claim. This is detailed in the above video.
  • Premium Structure. You want your premiums guaranteed and fixed. With mortgage life insurance your premiums are tied to the length of your mortgage. When your mortgage renews, if you move to a different bank then your premiums will increase. With a term life insurance policy, premiums are fixed and guaranteed level for the ‘term’, which could be 10, 20 or even 30 years.
  • Conversion. This is a huge risk with mortgage insurance, and one rarely talked about. If you become uninsurable under a mortgage life insurance policy and then switch banks you won’t be getting new insurance – you’re over and done.Most term life insurance policies offer (for free) a conversion option that lets you exchange your term policy for a lifetime coverage without a medical exam. If you become uninsurable with a term policy, just fill out a conversion form, no medicals, and you’ll have coverage for the rest of your life, at rates determined primarily by your health class from back when you first bought the term policy.
  • Coverage structure. You probably want level coverage. But mortgage life insurance has coverage tied to your mortgage. As you pay off your mortgage your coverage goes down by the same amount. Yet your premiums remain the same. A term life insurance policy has coverage that is level as long as you keep the policy in force.
  • Beneficiary. Yes your mortgage is paid off with mortgage life insurance – the proceeds are paid to the bank and wipes out your mortgage. But what if your beneficiaries don’t want to pay off the mortgage? What if they want some of that money for education, debt, some time off work, or anything else life related? A term life insurance policy pays the beneficiary of your choosing, with no conditions on the funds. They can decide afterwards if they want to pay off the mortgage, or continue to make monthly payments, or sell the house, or none of the above.

Mortgage life insurance simply has too many flaws and drawbacks, without any corresponding advantages. If you’re looking to insure your mortgage, look at an individual term life insurance policy instead.

Life insurance for children

Why should you purchase life insurance for your children? First, and perhaps most importantly is to guarantee future insurability. By locking in life insurance coverage when they’re a child, you guarantee that they have that coverage when they’re older no matter what happens to their health. My own children are a good example, my eldest had a brush with cancer in their early 20’s and now the $250,000 insurance policy I purchased on them when they were younger is the only life insurance readily available to them.

Secondly, parents often purchase life insurance on their children as a financial planning suggestion, or a gift. This was why I purchased life insurance on my kids – I wanted to show them the value. And frankly at the low premiums it was better than another XBOX game.

You’ll need to determine the amount of coverage first. Generally smaller amounts such as $25,000 or $50,000 are common. However if you’re purchasing insurance to guarantee future insurability you may want to consider a larger amount – enough to look after them if they do become uninsurable. Again relating this back to my personal situation, I purchased $250,000 as I figured it was enough to cover a small mortgage when they got married and bought a house. Ultimately there’s not a lot of science or math around figuring the amount so most people go with a number that they’re comfortable with.

There’s a variety of common types of life insurance used with children.

  • Term insurance is available from some specific companies in Canada, but rarely used unless you’re covering a student loan when they’re older. When guaranteeing future insurability or as a gift most people are seeking permanent lifetime coverage which term insurance is not.
  • Quick pay, par whole life. This is a common policy type with children and one you should investigate fully. Whole life insurance lasts a lifetime, but the ‘quick pay’ type has premiums that are paid up generally in 20 years (so by the time you gift the policy, there’s no more premiums). The ‘par’ part is important because it allows your child’s coverage to grow over time without any medical. Par or participating whole life can be selected with an option called Paid Up Additions. Paid up additions mean the life insurance coverage grows yearly. So if your child becomes uninsurable this feature lets them get a bit more life insurance without a medical exam.
  • Term 100 or Guaranteed Universal Life. These policies, when paying the minimum premium, provide level life insurance coverage and level guaranteed premiums for life. This is the type of insurance I purchased, but it is not common. My constraints were that I wanted the least expensive policy with no bells and whistles, and I purchased enough that I didn’t feel that an increasing coverage amount was necessary. So, this type is a consideration but is the bare bones version and not common.
  • Universal Life. A typical universal life policy will have an investment component. I am not a fan of these policies as they are not guaranteed – and over long timeframes things can go very bad; the policy can become unaffordable or implode. Those downsides are incompatible with the intention of guaranteeing future insurability and providing a lifetime gift. Kind of sucks if you gift a policy to your kids and when they turn 50 they find out that the policy they thought had no more premiums instead is asking for large and increasing premiums going forward.

There are other options, but they are less common. For most people looking for an off the shelf solution, you should discuss a ‘quick pay par whole life’ policy with paid up additions.

Accidental Death Benefit

Accidental death benefit (ADB) is a rider that pays out if you die in an accident. Here, accidental roughly means the opposite of ‘for medical reasons’ rather than the opposite of ‘on purpose’. To clarify further, accidental death benefit does not pay out for death due to medical reasons such as heart attack, cancer, or stroke.

Should you purchase accidental death benefit as a rider on your term policy? The answer is most likely no – it’s generally seen as counter to basic life insurance principles.

Lets say you determine that you need $100,000 of life insurance. That $100,000 is probably based on loss or expenses incurred at death. It is likely NOT dependent on how you died. And that’s the basic problem with ADB; you need life insurance because you’ve died, not based on ‘how’ you died. With ADB you could possibly pass away and the policy doesn’t pay out.

Worse, it’s not ‘possibly’ the policy won’t pay out – it’s ‘probably’ the policy won’t pay out. As I like to say (I am in insurance), we all die the same way – cancer, heart attack and stroke. The World Health Organization has shown that of the top 10 ways to die, 9 of them are medical – only one of them would qualify for accidental death. And that cause (Road death/injury) is a very distant 7th of the 10.

Emotionally we all think we’re going to die as the result of an accident; in a car accident or in a plane crash. But in practice that’s unlikely. You and I are probably going to die for medical reasons. And that makes ADB a poor bet, even if it fits with our emotional reaction to how me might pass.

Children’s protection rider (CPR)

Children’s protection rider (CPR) is an inexpensive way to get a small amount of life insurance on your children. Added as a rider to your base life insurance policy, it covers them until they are adults, at which point the rider would expire

Companies are fairly inconsistent with their CPR provisions, and practices vary wildly. So rather than doing a comparison, I’m going to offer a few things you should look into when purchasing a rider.

CPR riders are generally available in increments of $5000, to a maximum of $25,000 or $50,000.

Some CPR riders are priced per individual child, some companies however charge a flat fee to cover all children. One isn’t necessarily better, they’re just two different ways to determine the premiums.

Upon adulthood, most CPR riders allow your now-adult child to transition their CPR coverage to an individual policy (very useful if they’ve become uninsurable in the interim – this gives them an individual life insurance policy without taking a medical exam). Importantly, companies offer different multiples of coverage on the new policy – i.e. some companies may offer coverage in the new policy of 2,3 or even 5X the coverage in the original children’s protection rider.

You should also know that CPR can normally only be purchased with a new policy – it generally is not available as an addon at a later date. You’ve got to buy it when you purchase your policy, or not at all.

Given that premiums are often in the $5-$10/month range, CPR is a reasonable purchase if you’re looking for a small bit of life insurance on your children.

Life insurance for stay at home mothers/parents (Canada)

Wondering how much life insurance a stay at home mom needs? (Equally applicable to any stay at home parent).

I’m going to introduce two distinct ways to rationally determine how much life insurance you may need in that situation.

First, we’re going to base this on our income replacement calculator. That calculator determines the amount of life insurance you need to replace your income, over a time period. Works well for those who generate an explicit income. But as a stay at home parent, you don’t have an external income. So now what?

The answer is to treat estimate your ‘income’ as the monetary replacement value of the services that would need to be replaced upon your death. There’s no right number here, it’s based on your best guess and assumptions.

Say you decide that to replace your homecare and child rearing work with someone else, and that would cost you $20,000/year. Then you can use the calculator linked above and run the calculation using 100% of $20,000. You’re sort of using your ‘value’ to the home as your income.

I’ve run these numbers repeatedly through the years and using common assumptions you’ll typically end up at $250,000-$500,000. Numbers in this range would be reasonable based on the above assumptions.

The second way to determine your amount of coverage is again based on an assumption – the assumption that one person’s financial replacement value is the same as the other’s in a partnership (you’re both worth the same). Or more specifically, that one person is not worth ‘less’. Using those assumptions you can throw out the above calculator and simply look at the same amount of coverage as your partner.

Both ways are equally valid. Just decide what assumptions suite you best.

30 year term life insurance (Canada)

30 year term life insurance Canada is a newer policy type (relatively speaking). It’s characterized by premiums that are level for 30 years and a level death benefit. Commonly both the premiums and the death benefit are fully guaranteed.

At the end of the initial 30 years (at the renewal), 30 year term policies generally continue in force with the same death benefit, but at a much higher premium. Those increased premiums at renewal are so high as to be unaffordable. Therefore you should assume that a 30 year term policy is really only suitable for insurance needs no longer than 30 years.

30 year term is commonly purchased by consumers in their 20’s and 30’s looking to provide insurance coverage for their family. 30 years is a good match for family needs at that age, as it gets most people through their child-rearing years, mortgages, and income earning years.

When shopping for 30 year term there’s two additional things you should look at. First, you should also shop for term to age 65 (as the durations are often similiar, but premiums could differ). Secondly, you should premiums compare with 20 year term. Even if want insurance for 30 years, in some cases 20 year term is so much cheaper that people will purchase a term 20 policy instead (and assume they’ll worry about insurance again in 20 years). I’ve no idea why this is, but I find that the cost difference really starts to run away around age 32 – before that age 30 year term is seen as price viable against a 20 year term. After age 32 the differences in price between a term 30 and term 20 are great enough that some people will opt for a term 20 instead.