The Math behind Whole Life and Term Insurance (2024)

By Steve Stewart on August 20, 2012

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This episode is my contribution to the #LifeAWARE Life Insurance Movement started by Jeff Rose at GoodFinancialCents.com.

Life Insurance is a necessity for anyone who is married and especially someone who has children. The choices between one type of life insurance and another can become daunting, but it doesn’t have to be.

There aretwo primary types of Life Insurance: Whole Life (permanent, lifelong) and Term Life (temporary). While I can not make a blanket statement to say you should do one and never buy the other, there are a lot arguments that can be made to show that Term Life is the better answer for the general population – and I have the math to prove it!

Mixing is for cake batter

Remember to save in savings, invest in investments, and insure through insurance. Do not mix these up or you will worry because you aren’t getting the returns you wanted, be in a bind because your savings are not easy to get to (illiquid), or have paid too much for a product that is trying to be two things at once.

What is your mindset?

Before we get started you must have a long-term mindset. Do not make the decision on what type of life insurance to buy based on price and certainly do not make the decision based on “expected returns”. How long you have life insurance coverage depends on your financial plan for the next 10-25 years, which determines which type of insurance you should buy. Thinking long term can save you THOUSANDS of dollars!

The math behind Whole Life

Using the scenario of a 30 year old male in good shape looking to buy a $250,000 policy we can determine:

• He will pay about $178 a month
• In 20 years it will cost him $42,720
• In 20 years his Whole Life policy will build up a savings account of $34,000
• In 40 years he will have paid $85,440 but will have $124,000 in the savings portion
• If you cash out, you no longer have the coverage
• If you die, you don’t get the savings – only the $250,000 face value of the policy

The math behind Term Life

If we were to offer this 30 year old the same coverage but as Term Life Insurance:

• He will pay $13 a month, $165 a month cheaper
• It will have cost him $3,120 for the entire 20 years, $39,000 less for the same coverage
• There is no savings built up inside the policy. Saving money is your job, not your insurance company’s
• After 20 years you either drop the coverage, test for a new policy, or pay quite a bit more to continue the same policy

Put your Financial Planning hat on

I am not an insurance salesman but I am here to teach the difference between these two types of life insurance coverage. It would be irresponsible for me to say “buy term because it is cheaper” because after the term is over you have no coverage. But that is OK if you follow the rest of my advice. You see, if you do what I teach then the following events will put you into the position where you shouldn’t need life insurance:

• Pay off all your debt (which should take a lot less than 20 years)
• Invest for retirement (which you should do whether you buy Whole Life or Term Life anyway)
• Your kids have grown up and moved out on their own (or close to it)
• Your 15 year mortgage will be paid off

Invest in Investments, Insure through Term Insurance

Since this guy can be spending $165 less by purchasing Term Life Insurance instead of the Whole Life policy, he can save or invest the difference:

• $165 a month (difference between the Whole Life and Term policy) put under a mattress will turn into $39,600 in 20 years – $5,600 more than the Whole Life policy
• $165 a month saved in investments earning 6% over 20 years turns into $46,791 or $334,000 in 40 years
• However, continued investing after the policy has reached its term in an account that averages 10% and it turns into $75,603 in 20 years or more than $1,000,000 (that’s a million dollars) in 40 years

Long-term financial PLANNING has caused you to become self-insured by doing all the right things with your money while covered under a Term Life Insurance policy and you enjoy the continued success of building wealth by eliminating debt, paying off the house, and investing on your own.

UPDATE: Life Aware Vid-torial

I posted a video showing how the math works. Go to http://stevestewart.me/vid-torial-the-math-behind-whole-life-and-term-life-insurance/

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