BUY TERM AND INVEST THE DIFFERENCE?
Have you ever come across a client (or their CA) who think they/their clients can keep buying term insurance and investing the difference better than the insurance companies fund?
One of the most common objections financial advisors who sell life insurance tell me about is the around the concept of "buy term invest the difference.
What is the concept of buy term invest the difference
First let's start off with how the concept of "buy term invest the difference" works. Buy Term Invest the Difference is a concept that compares the financial implications of buying a term insurance policy and investing the premium difference to that of a permanent product in an alternate vehicle.
Buy Term Invest the Difference assumes the same total level of funding for each vehicle. With permanent life insurance, the entire deposit goes into the policy. With term insurance and an alternative investment(usually taxable), deposits are first allocated to the term insurance, with any excess funds going to the investment.
In years if there are no deposits in the permanent insurance, the difference vs the term insurance policy reduce the value of the investment accumulation. If the investment has insufficient value to cover the term insurance costs, the alternative investment will result in negative values. It is also possible for a term policy to expire leaving no premiums or coverage. When you die, the life insurance policy proceeds are paid directly to your beneficiary tax-free as long as the policy is inforce.
With term insurance and a taxable investment, the taxable investment is liquidated, the final tax is paid, the remaining amount is distributed to the beneficiary of your estate. Net estate values reflect the insurance proceeds (if the policy has not lapsed), plus the after-tax investment balance, if applicable.
Ok so now that we are on the same page with the concept of buy term invest the difference, let's look at some of the risks.
Risk 1Client does not invest the difference (or dips into it in emergencies) - Almost anyone in the financial services industry will tell you that client discipline may be the biggest hurdle to achieving your financial goals. We all plan to save and know the importance it has to achieve our retirement goals, however executing that plan takes real discipline. Even the most diligent savers can have their plan derailed by unpredicted expenses or uninsured illnesses. Remember 33% of Canadians have a month or less saved for emergencies and where do you think the first place they are going to go for immediate funds? Their investments.
Risk 2Client is not healthy enough to keep buying term - Often we assume that we can purchase as much insurance as we want and get the best price, however, any experienced advisor can tell you that getting an offer is not always guaranteed. If clients make the assumption they will be able to keep buying term insurance and can keep high levels of protection at low cost while they are in the accumulation phase they may be in for a rude awakening. Without this safety net in the early years before the investments have time to mature they can create a liability for their family. Often the protection aspect of the permanent insurance policy is what lets people spend the cash they have accumulated in retirement, particularly if their investments did not perform as well as anticipated.
As my stepfather would say "Term is like a diaper and at some point, you have to change it."
The other reason this strategy may not work is even if risk 1 and 2 pan out the math doesn't always make sense. I have always been taught that insurance funds a liability at a lower cost and when you look at the cost of term insurance as we age we often don't have enough to invest or we create a large liability.
What can you do?
So what can you do if your client wants to take this risk but you don't think it is prudent?
One way to handle this objection or to give full disclosure around it is to use our buy term invest the difference metric to show how those renewals (even if re-written) will erode the amount there is to invest.
Watch our quick how-to video that shows you how you can illustrate this concept and help sell the right kind of coverage for your clients needs!
Pair your personal LDA report with this article from the Investment Executive.