One of the most common questions people asked themselves when they are considering the purchase of life insurance is whether they should choose a term insurance or a whole-life insurance.
In this article, we will be explaining what this concept means, and how the average person could use this strategy not only to provide sufficient life insurance coverage for themselves, but also additional retirement funds for their old age.
What is a term insurance?
Term insurance is a form of pure insurance where policyholders are covered for a fixed period of time. In the event of death or terminal illness within this period of time, policyholders will receive an insured sum of money.
It is worth noting that if you have dependents that are reliant on your income (e.g. spouse, children) or future income (e.g. elderly parents who may need your financial support), you should seriously consider getting life insurance today. You can email us at [email protected] if you are looking for someone to help you.
Difference between term and whole-life insurance
When you purchase a life insurance, you have to choose between term insurance and whole-life insurance.
The main difference between the two is that whole life insurance has a cash savings component attached to the policy. Unlike term insurance, which does not provide any cash returns upon the policy lapsing or being cancelled, whole life insurance provides a surrender value (if you cancel the policy), or a death benefit payout (till the age of 99), even after you have stopped paying the premiums. Most whole-life policies would allow you to choose how many years you would like to pay the premiums for. Naturally, the shorter the number of years you are paying, the higher the premium would be.
If you do reach the age of 99, the policy will mature and you will get the cash payout.
Here is a simple illustration to briefly explain the two from a cost point of view.
- 30-year old male
- Coverage of $300,000
- Coverage Till 65
We used the CompareFirst platform to find the cheapest coverage.
Whole Life Insurance:
A whole life policy is trickier to compare because there are so many variances in products across different companies. We decided to use AXA once again, because they have a product that could provide a similar type of coverage to what our term insurance is providing.
- 30-year old male
- Coverage of $300,000
- Policyholder chooses to pay for 25 years
At this point in time, we think it is important for us to weigh in with our views that while both term and whole life insurances are life insurances, we believe they are fundamentally different types of products. Hence, a like-for-like comparison between the two is challenging because, cost aside, there are other factors that we need to take into consideration.
For simplicity sake, we will simply compare the two from a cost perspective.
For a whole-life insurance to be able to provide the additional cash value component in its policy, you will need to significantly overpay for the insurance coverage in the earlier years.
This can be seen from the difference of $1,641 in premium per year for the first 25 years.
What does buy term and invest the rest mean?
Whenever people talk about buying term and investing the rest, they are referring to buying a term policy that provides you with a similar coverage as a whole life policy, and then investing the differences that you would be saving.
In our example, you would have saved about $1,641 a year if you opt for the affordable term insurance, instead of the pricier whole life option.
We will assume an investment return of about 5% a year over the long run. For comparison, the CPF Special Account gives a risk-free return of between 4% to 6%. We assume that the person stops their investment at the age of 55, the same age where they would stop paying for their whole life policy.
At age 65, their term insurance will lapse. The premium of $12,880 that they have spent for the term insurance is gone. However, they now have a portfolio worth $127,575. This portfolio was accumulated simply by investing the differences in premiums ($37,345) between the term and the whole life insurance.
Build Your Own Portfolio
Whether or not you prefer a term or whole-life insurance, the same objectives still apply. We don’t only need to provide life insurance coverage for ourselves today, but we also need to take care of ourselves in the future by building a retirement portfolio at the same time.
A “buy term and invest the rest” approach is a perfectly logical way to tackle both these needs at the same time.
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