Kevin Purcell, Attorney at Law

TERM VS. PERMANENT INSURANCE

Who is the Heavyweight Champ?

By KEVIN PURCELL, ATTORNEY AT LAW
Certified by the Ohio State Bar Association as a
Specialist in Estate Planning, Trust and Probate Law
19111 Old Detroit Road
Suite 206
Rocky River, Ohio 44116
440.331.5883
fax: 440.331.9125
kevINtrust@stratos.net
www.ohioestateplanning.com

                                                ©  Kevin Purcell, 2005, 2006, 2007

  

We=ve all seen those  Ainsurance-on-the-internet@ T.V. commercials touting how dirt cheap term insurance is:  Buy term insurance instead of that pricey permanent insurance.  And, of course, some of the investment gurus in the media will provide the added advice that investing the difference between the two will make you the champ.

 

But which product really delivers the knockout punch? Let=s take a look at such a match up between these two contenders:

 

Investment advisor Suze Orman, who has put her money on the ABuy-Term-and-Invest-the-Difference@ theory in an article from her website, imagines a prize fight between the two investors: In one corner, the investor buys a permanent form of life insurance.  In the other, an investor buys term insurance and invests the difference.

 

When these two fighters weigh in, however, here is the tale of the tape.  Get lots of popcorn, because this fight is no 15 rounder. It=s the fight of the century, or at least half of one: a 50 year Alife expectancy@ fight. Only one fighter will be standing at the end. We=ll use Suze=s own stats from her article:   (overleaf…)

                    

The facts, quite frankly, don=t look so good for Tom. But the fight judges have announced the winner anyway: ATemporary Tom is the champ! His family will be better off with the term insurance approach!@ After all, everyone has heard Abuy term and invest the difference@ is the way to go, right?

 

I don=t think so. In reading Suze Orman=s article on her own website, I think I found seven fatal flaws in her argument. I will list them as the ASeven Assignment of Errors@. (I can=t help it, I=m a lawyer):

 

Assignment of Error One: If Tom were to die of a heart attack in the ring after 30 years, his family would have received much less than Paul=s family=s receipt of two million dollars!

 

After 30 years, Tom=s term insurance lapses. Soon thereafter, he keels over in the ring. As the table shows, he dies with only $653,000 in investments compared to Paul=s $2,000,000. Tom=s family is now a huge loser compared to the $2,000,000 guaranteed income tax-free death benefit Paul=s family will receive.

 Assignment of Error Two: Even if Tom were to break an ankle in the ring after some years, Paul=s family is still well over a million dollars ahead of Tom=s family!
 

Okay, so let=s just say Tom gets disabled during the fight. A broken ankle, whatever. He can no longer fight. Isn=t he just like a worker who somewhere in his or her career can no longer work? Where would such a worker get the money to keep making those investment payments to build up his or her investment to $1,967,000? Can=t do it. But most permanent forms of insurance have a provision in them that will pay the premiums in the event of disability.

 Assignment of Error Three: A Permanent insurance contract encourages what experts call the Aresistance of the tendency to consume@.
 

We are all consumers. Financial experts, however, emphasize that wealth accumulation comes from a developed, disciplined habit of Apaying oneself first@. With Temporary Tom=s need to make voluntary annual investments of $11,640 for everything to break his way, what happens when the he sees the flat screen TV with the built-in surround sound he Amust@ have? With a permanent insurance product such as whole life, on the other hand, the client=s motivation is naturally to resist this tendency to consume. Who buys luxury consumables while missing mortgage payments?

 

Similarly, insurance is forced savings. Who would ever have the discipline to save the premium dollars and leave them untouched? It does not happen. When you have committed to the premium payment, you will set aside the money.

 

Assignment of Error Four: Ms. Orman=s investment of 5% municipal bonds are not guaranteed and may not be realistic. With inflationary factors looming on the horizon, those 5% bonds may realize a lower asset value. Suze doesn=t want to use an example that would expose Temporary Tom to stock market risk, so she uses a hypothetical 5% municipal bond investment. Perhaps Suze is looking at the problem through rose-colored contact lenses. If interest rates spike, bonds suffer. Obviously, even a one or two percent overstatement of Tom=s bond portfolio return unrealistically inflates the return on his investment that she projects.

 

Assignment of Error Five: Ms. Orman=s suggestion that people don=t need or want to buy insurance when they are at or near retirement age is simply not true: Our experience is that  many people want to have life insurance when they are, say, in their 60's: insurance for a surviving spouse to live on; insurance to take care of children of a first marriage for a second-marriage client;  insurance to produce liquidity in an estate that does not have a lot of cash; insurance to protect loved ones= having to draw down on tax-deferred IRAs.  The list goes on.  

 

Let=s say Tom is 65 and wants a life insurance policy. Since his policy lapsed long ago, he will have to get a quote for both preferred and rated at age 65. His medical exam may indicate he is uninsurable. One experienced life insurance agent advises me for a healthy 65 year old, Tom=s premiums will be about $110,000 a year for $2,000,000 of permanent whole life insurance at this late age. If Tom is Arated@ i.e. has health problems, the rates could be anywhere between 25% and 100% more for the same coverage or simply not available.

 

Why the quantum jump in the price of permanent whole life versus term insurance? Simple: 99% of term insurance policies never pay out. For 99% of people buying term policies in their 30's or 40's, they are throwing away dollars early in life that have the capacity to compound interest over a long time horizon: a lost opportunity. When you need the insurance, typically later in life, Permanent Paul has it. Temporary Tom can=t get it, or will have to pay top premium rates for the privilege.

 Assignment of Error Six: In Ohio, the Cash Surrender Value of Permanent Life Insurance is Exempt from Ohio Estate Taxes and Immune from Creditors!
 

Paul is the winner when we look at state law, too. In the first place, Tom=s $1,967,000 in Suze=s hypothetical would be fully subject to Ohio estate tax. Under Ohio estate tax law, however, the insurance proceeds, if your estate planning documents are correctly drafted, are completely exempt from this tax. At a probable marginal rate of 7%, this favorable tax treatment will amount to an additional $140,000 savings. Tom falls further behind.

 

Ohio law, moreover, exempts in almost all situations both the death benefit and the cash surrender value of permanent life insurance proceeds from creditors. Tom=s traditional investment has no such protection. One lawsuit, and the invest-the-difference strategy could reduce the cash in Tom=s investment to zero. In contrast, the permanent life insurance=s death benefit and cash surrender value are beyond the reach of Paul=s creditors.

 

Assignment of Error Seven: Losing is simply not winning.

 

Is there anyone who can=t see this one? If you lose by a little bit, you still are the loser. On my calculator, $2,000,000 is always more than $1,967,000.

 

Even if we take all of Suze Orman=s assumptions as trueB-and she is an advocate of buying-term-and-investing-the-difference-Bthe fact is the best she can show is that if everything goes right, a buy-term insurance strategy can only come a close second to beating a buy- permanent-insurance strategy. And she sacrifices this $33,000 ($2,000,000 - $1,967,000) in order to forgo all the benefits of permanent insurance!

 

Moreover, notice that Tom, in order to come close to Paul at the end of their life expectancies, can never touch a penny of his investment as he needs every cent to continue to compound to try to get close to catching up with Paul=s $2,000,000 that Paul had from day one.

 Conclusion
 

There are also other features of permanent insurance which we will devote to another article: Certain forms of permanent insurance pay bonus dividends which can be used to increase the death benefit and cash surrender value. Or they can be used to pay the policy up early, leaving you with cash in hand to invest in whatever you please.

 

True, there are definitely specific situations where term insurance is a good product choice for our clients: for example, to fund a buy-sell agreement for a business venture designed to last a term of years or for, say, a young couple who simply can=t afford the cost of permanent insurance at that stage in their lives.

 

Clearly, however, for those with the sufficient cash flow and an interest in insuring loved ones from the 100% certain event of your death, after considering all the evidence, the boxing judges=decision is a no-brainer: Judgment reversed. Paul=s permanent insurance strategy is the  winner.