19/12/2024
Let’s do a deep dive into the Buy Term Invest the Difference strategy in life insurance, so that we understand the concept, it’s application, and it’s flaws.
Buy Term Invest the Difference was a marketing strategy brought by A.L. Williams (now Primerica) into Canada in the late 80’s early 90’s. At the time, the insurance industry had a bad habit of selling whole life insurance to consumers in applications that were perhaps inappropriate. A.L. Williams only sold term life insurance and promoted this strategy to combat the sale of whole life insurance to consumers (so, be aware Buy Term Invest the Difference isn’t perfect – it was designed to always sell term life insurance by a company with a bias).
So, the basic premise at the time with whole life was to use it as an investment. The industry would suggest that you purchase a whole life insurance policy at high premiums. Then when you were say age 65, you’d cancel the policy, receive the cash value for the policy, and use the money as retirement income.
A.L. Williams suggested that instead, if you purchased a much cheaper term policy (buy term) and put the difference in premiums saved over the whole life policy into an investment (invest the difference), then at age 65 you’d have more money with this strategy compared to the whole life.
And, this is mostly – but not always true. In practice it’s almost always true, and in some less common situations where you’ve maximized your RRSP’s, TFSA’s and RESP’s, the opposite is true.
Lets run some numbers. We’ll assume a 45 year old male nonsmoker seeking $500,000 in life insurance. Here’s the two policies:
Term: RBC Insurance, 20 year term, premiums of $779/year
Whole Life: Foresters Non-Par Whole Life: premiums of $5800/year.
And here’s the breakdown assuming 6% rate of return (untaxed, so we’re putting the money into an RRSP)
Age | Term Life Insurance | Invested Difference Year End | Whole Life | Whole Life Cash Value |
---|---|---|---|---|
45 | 779 | 6918 | 5800 | 0 |
46 | 779 | 14253 | 5800 | 0 |
47 | 779 | 22027 | 5800 | 0 |
48 | 779 | 30267 | 5800 | 0 |
49 | 779 | 39002 | 5800 | 0 |
50 | 779 | 48261 | 5800 | 0 |
51 | 779 | 58076 | 5800 | 0 |
52 | 779 | 68479 | 5800 | 0 |
53 | 779 | 79507 | 5800 | 0 |
54 | 779 | 91197 | 5800 | 0 |
55 | 779 | 103587 | 5800 | 23250 |
56 | 779 | 116722 | 5800 | 37100 |
57 | 779 | 130644 | 5800 | 44200 |
58 | 779 | 116722 | 5800 | 51460 |
59 | 779 | 130644 | 5800 | 58880 |
60 | 779 | 145401 | 5800 | 66460 |
61 | 779 | 161044 | 5800 | 74200 |
62 | 779 | 177626 | 5800 | 82095 |
63 | 779 | 213834 | 5800 | 90150 |
64 | 779 | 254517 | 5800 | 98365 |
65 | 779 | 276707 | 5800 | 105625 |
We've assumed two other things in the table above. First, since the invested difference with the term policy is going into an RRSP, you'll receive a tax refund. We've assumed a 30% refund of the difference in premiums also going into the investments. Secondly, the cash values of the whole life assume a 20% tax rate - the values are thus after tax. The values in the RRSP are before tax.
Now that’s startling! For the same life insurance coverage, at age 65 with a whole life policy you would have about $84,500. If you’d purchased term life insurance, you’d have $276,707 in savings. That’s a huge difference, with a huge impact on your retirement, and a good example of when not to use life insurance as an investment.
There are some hidden assumptions in this comparison that never get mentioned. They don’t change the results necessarily, but it’s important to fully understand the comparison.
First the invested difference with the term policy is liquid – it’s in your RRSP and if you needed cash partway through you could access it. The cash value of the whole life policy is not liquid – you have to cancel the insurance to obtain the premiums (there are a couple other ways to get the cash value but none are attractive).
Secondly, we’ve assumed a 6% rate on the invested difference. That’s clearly not a guaranteed rate. The whole life cash values shown are guaranteed – so we’re comparing non-guaranteed returns to guaranteed returns.
Thirdly we’ve shown the whole life cash values as after tax, because you have to pay taxes when you collapse the policy and access the cash values. The invested difference for the term policy is shown as inside an RRSP and so does not reflect taxes which would be paid as savings are withdrawn at retirement.
And lastly, at age 65 the only practical way to access the cash surrender value is to collapse the whole life policy. That leaves you with no insurance. With the term policy that’s not the case. You don’t have to cancel the term policy to access the invested difference in premiums – it’s in your RRSP and not connected to your term life insurance policy. You could renew your term policy (keep it in force, but at higher premiums) or you can convert the term to permanent life insurance at that time. So the term policy in addition to the savings, gives you the option of more life insurance going forward, the whole life option does not.
We’ve also assumed that the invested difference is going into an RRSP. If it’s not, then we might actually arrive at the opposite conclusion. See our article on Insured Retirement Plan for an example of when this is the case.
Overall the strategy is mostly correct and generally comes to the correct conclusion – if you have RRSP/TFSA room AND need coverage for a defined period of time, then you are better off financially to simply purchase a term policy and no comingle insurance and investments.
If you have any questions about your life insurance coverages, please contact The Term Guy at (416) 642-6820.