Life Insurance: What is Buy Term, Invest the Difference?

When considering life insurance, you’ll typically be looking at either whole life or term life. In brief, whole life insurance provides you with a guaranteed death benefit so long as your premiums are paid, while term life insurance covers you for a fixed period of time (e.g. 25 years).

A great way to think of term life insurance is that it’s a safety net should you pass away. The death benefit can be used by your family and loved ones to cover things like funeral expenses, mortgages, debts, and education, as well as provide a bit of a cushion while they get back on their feet. In other words, it’s used to fill in gaps of income that your premature passing may cause. With lower premiums than whole life policies, term life is also an affordable way to get the coverage you need.

READ: Term life vs. whole life insurance

A prominent philosophy when it comes to life insurance is “buy term, invest the difference.” But what does this mean, and how can it benefit you?

Term life vs. whole life insurance pricing

Below is a table that provides approximate costs of term life insurance. The rates are based on a 25-year term, and data is provided for both males and females.

 

NOTE: Term life data not provided past age 55 as most policies do not extend to 80 years of age.

Let’s consider the following example: you are a healthy, non-smoking male who is 30 years old. You purchase the cheapest 25-year term life policy you find which sets you back $449 per year for $1 million of coverage. At the end of the 25 years, you’ll have paid $11,225 in premiums. Now, this is no small amount of money, but if you pass away before the 25-year term ends, your life insurance beneficiaries will be entitled to $1 million, tax-free.  

Now, let’s examine the approximate costs of a whole life insurance plan.

 

The same healthy 30-year-old male could expect to pay around $2,927 per year for the whole life policy – a difference of $2,478. As you can see, you save a lot of money by selecting a term life over a whole life policy.

While whole life policies provide a certain investment benefit, the amount of interest you get on the policy typically won’t be a lot. The amount you get paid back is primarily composed of the insurer’s dividends, and in most cases, it’s up to the insurer to decide how the money is invested initially. While your rate of return is usually consistent, the volatility of the insurer’s investments is typically low and therefore doesn’t offer significant returns. Any return you do receive also has to be compared to the amount of money you’ve put into your policy. When you deduct one from the other, you might find that the fees still outweigh the returns.

If you are able to afford $3,000 a year for life insurance at the age of thirty, you could be better off purchasing a term life policy for an annual rate of $500, then taking the remaining $2,500 and investing in mutual or index funds. A quick search of Canadian index funds reveals that the average yearly interest rate hovers around 7%, compounded over time – that can quickly add up in your favour.

Get interest(ed) in buy term, invest the difference

Let’s say you invest $2,500 a year in an index fund and receive an interest rate of 7% per year. After 10 years, you will have invested $25,000 but have $36,959 in your account. Considering the fact that the annual interest rate will fluctuate, and you could potentially contribute more to your investment on a yearly basis, you’re looking at a nice amount of interest over the 10-year period.

Purchasing a whole life policy at a $3,000 annual rate might generate you 4% in interest a year, but the high premiums and additional fees could decrease the return on investment. Some years you may easily afford that amount, but others might make scraping that money together more difficult.  

Whole life policies generally offer a cash surrender value (CSV), but if you’ve been paying into one for 10 years and then switch to a term life policy, you’ll probably be paying higher premiums due to your advance in age. Why not make it easy on yourself and invest in the term life policy upfront, and take the amount you’re saving to buy into a mutual fund?

READ: Is life insurance taxable in Canada? 

The bottom line

Both term life insurance and whole life insurance offer financial protection for your named beneficiaries when you pass. When shopping for the best life insurance, take time to consider what the death benefit will be used for. Ultimately, the money you save with a term life policy can be a great asset, especially if you carefully invest your savings. Smart investing can lead to strong financial returns, so your loved ones can remain financially secure after you’re gone.

ALSO READ

• Life Insurance Trusts, Explained
• How much life insurance do I need?
• Saving vs. investing: the pros, cons, and differences explained