The concept is simple - buy term life insurance and invest the difference. When buying life insurance the choices are term or permanent. It's important to understand the difference before implementing the "buy term invest the difference" strategy.
Term life insurance covers the policy holder for a set number of years (five, ten, fifteen, twenty or thirty are the most common terms) with a set payout amount. In the event the holder dies within the designated number of years of the policy, the beneficiary receives the payout. These policies can be obtained with a low monthly premium, which makes them popular among individuals and families who do not have a large savings. Like auto or home insurance, an individual may pay the monthly premium for years and never actually use the benefit. In fact, it is estimated that less than 1% of term policy holders actually die within the term. But, like all insurance, the premium is paid for "risk protection."
Permanent insurance is more expensive because it operates on the premise the policy owner will "self insure" by combining a savings vehicle with the insurance program. Instead of one monthly premium for a set payout, a holder of a permanent policy will spend a larger portion each month to build cash value. Unlike the term policy, a permanent policy will ALWAYS payout eventually, so what you invest will be returned to either you or your beneficiary. Permanent policies have investment options similar to pension plans, IRA's, or mutual funds. The difference is that a life insurance policy is part of the package.
A policy holder implementing the "buy term and invest the difference" concept separate their investments from their insurance. Rather than paying a larger monthly premium, individuals pay a smaller premium for term life insurance and set aside the difference of the smaller premium from the larger. Ideally, this difference will be placed in a tax-deferred investment vehicle. There are several advantages to this approach.
If done correctly, investors will eliminate the need for insurance as their investments grow, in a sense making them "self insured." The intended purposes of life insurance could be considered "temporary" in nature - paying off debts/mortgages, providing a higher education for dependents, and creating cash reserves to replace the income lost. When an individual has cash reserves large enough to cover these expenses, they can consider themselves "self insured."
Other advantages exist as well, like an immediate accumulation of the money invested and a wider variety of investment options. To say the least, the choices available with investments and life insurance are many and can be confusing. Consult with your insurance agent to determine what policy is best for you. But remember, the worst insurance is NO insurance!
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Date Published :
Feb 20 2009