About a month ago, I gave a talk on insurance at a personal finance event. During the talk, I outlined how most of our protection needs can be met by using low-cost term insurance and that there is no need to buy costly whole life plans.
After the event, someone shared an article on Facebook showing that what I said might not be valid. The writer of the article stated that a whole life plan is actually cheaper than a term plan if you consider the accumulated guaranteed and non-guaranteed cash value.
He concluded that the whole life policy provides better value in the long term with a projected cash value of $156,504 (based on a cover of $100,000 with critical illness coverage and limited premium payment of 25 years) for a male aged 30 if you do not make a claim, live until 75 and wish to surrender it.
On the other hand, you get nothing back when a term plan expires, assuming its cover is until age 75. And if you want insurance coverage at that time at age 75, no firm will insure you.
While the analysis seems a pretty clever way to show why whole life might be a better choice over term insurance, the thinking is actually not sound and is biased towards the more expensive whole life plan. Let me explain.
• We need to go back to the fundamental reason why we buy insurance. It is for protection and not savings or investment. This is because if getting an investment return (like cash value) is what you want, there are other better instruments to use.
• So, if insurance is for protection, what are we protecting against when we buy a critical illness plan? The basic reason is really to protect against a loss of income due to contracting of a critical illness.
• If our reason for buying a critical illness plan is to pay for medical expenses not covered by Integrated Shield Plans, then a whole life plan is suitable and there is no need to compare against the term plan. This analysis is then redundant.
• If we are buying a critical illness plan to protect against income loss, we do not need whole life cover. We need it only until we no longer have an income to replace. For most, it would be until age 65, 70 or at most 75.
• In terms of the amount of coverage, we probably need about three to four years of our income. So, if we earn say $80,000 a year, we will need about $320,000 of coverage.
In his article, the writer used a more expensive term plan to compare against the whole life plan.
But I found a cheaper option by combining two insurance plans - a standalone term plan and a standalone critical illness plan - and it offers a whopping 30 per cent savings compared with the term plan he used which had an annual premium of $1,528.
So instead of paying premiums of $2,607 a year for a $100,000 whole life plan with critical illness coverage, we can pay a lower premium of $1,173 a year for a $100,000 term plan with critical illness cover till age 75.
But if we want to cover ourselves sufficiently (say up to $320,000), we will see at once why using a whole life plan becomes really unaffordable.
But what about the cash value we can get at age 75 when we surrender the whole life plan? Wouldn't that make buying the whole life plan better than term insurance?
Yes. But since insurance is for protection, you should focus on getting yourself fully covered instead of the possibility of a cash value at age 75. To sacrifice coverage for a future cash value goes against the primary reason why we buy insurance in the first place. That is not wise.
And by the way, we are getting cash value from a whole life plan only because we are giving the insurer extra premiums and, in this example, an extra $1,434 a year (derived from the difference between $2,607 and $1,173) for 25 years to invest.
If we really want the same return ($156,504) as the whole life plan, we can invest the $1,434 a year from the savings in buying the term plan over the next 25 years (the same premium term as the whole life plan in this example) into a portfolio that can yield 4.5 per cent a year to give you almost the same cash value of the whole life plan at age 75.
This can be reasonably achieved by a portfolio with an asset allocation of 60 per cent equities and 40 per cent bonds.
But we are not buying a term plan so that we can invest the rest to get a return.
We buy term insurance because it is the most affordable way to be fully covered. In this regard, I have written a comprehensive guide (e-book) to insurance planning and you can download it for free at advice.moneyowl.com.sg to understand more.
Since 2003, I have been writing about using term plans instead of expensive whole life plans for protection. For that, I have drawn flak from advisers. But why am I so conscious about lowering the cost of insurance?
It is because we do not plan our insurance needs in isolation from our total financial planning needs. We all have limited financial resources but unlimited needs and wants.
As an adviser, I need to ensure that after the insurance needs are taken care of, I leave enough money for clients to plan towards their other areas of needs such as retirement and funding their children's tertiary education - and still leave enough money to live life now.
Because life does not begin at retirement. Life begins today. Financial planning is not just about planning for the future, it is also about making sure we can live a meaningful life now.
• The writer is chief executive of Providend, a fee-only retirement financial adviser, and also executive director of MoneyOwl, Singapore's first bionic financial adviser.
After the event, someone shared an article on Facebook showing that what I said might not be valid. The writer of the article stated that a whole life plan is actually cheaper than a term plan if you consider the accumulated guaranteed and non-guaranteed cash value.
He concluded that the whole life policy provides better value in the long term with a projected cash value of $156,504 (based on a cover of $100,000 with critical illness coverage and limited premium payment of 25 years) for a male aged 30 if you do not make a claim, live until 75 and wish to surrender it.
On the other hand, you get nothing back when a term plan expires, assuming its cover is until age 75. And if you want insurance coverage at that time at age 75, no firm will insure you.
While the analysis seems a pretty clever way to show why whole life might be a better choice over term insurance, the thinking is actually not sound and is biased towards the more expensive whole life plan. Let me explain.
• We need to go back to the fundamental reason why we buy insurance. It is for protection and not savings or investment. This is because if getting an investment return (like cash value) is what you want, there are other better instruments to use.
• So, if insurance is for protection, what are we protecting against when we buy a critical illness plan? The basic reason is really to protect against a loss of income due to contracting of a critical illness.
• If our reason for buying a critical illness plan is to pay for medical expenses not covered by Integrated Shield Plans, then a whole life plan is suitable and there is no need to compare against the term plan. This analysis is then redundant.
• If we are buying a critical illness plan to protect against income loss, we do not need whole life cover. We need it only until we no longer have an income to replace. For most, it would be until age 65, 70 or at most 75.
• In terms of the amount of coverage, we probably need about three to four years of our income. So, if we earn say $80,000 a year, we will need about $320,000 of coverage.
In his article, the writer used a more expensive term plan to compare against the whole life plan.
But I found a cheaper option by combining two insurance plans - a standalone term plan and a standalone critical illness plan - and it offers a whopping 30 per cent savings compared with the term plan he used which had an annual premium of $1,528.
So instead of paying premiums of $2,607 a year for a $100,000 whole life plan with critical illness coverage, we can pay a lower premium of $1,173 a year for a $100,000 term plan with critical illness cover till age 75.
But if we want to cover ourselves sufficiently (say up to $320,000), we will see at once why using a whole life plan becomes really unaffordable.
But what about the cash value we can get at age 75 when we surrender the whole life plan? Wouldn't that make buying the whole life plan better than term insurance?
Yes. But since insurance is for protection, you should focus on getting yourself fully covered instead of the possibility of a cash value at age 75. To sacrifice coverage for a future cash value goes against the primary reason why we buy insurance in the first place. That is not wise.
And by the way, we are getting cash value from a whole life plan only because we are giving the insurer extra premiums and, in this example, an extra $1,434 a year (derived from the difference between $2,607 and $1,173) for 25 years to invest.
If we really want the same return ($156,504) as the whole life plan, we can invest the $1,434 a year from the savings in buying the term plan over the next 25 years (the same premium term as the whole life plan in this example) into a portfolio that can yield 4.5 per cent a year to give you almost the same cash value of the whole life plan at age 75.
This can be reasonably achieved by a portfolio with an asset allocation of 60 per cent equities and 40 per cent bonds.
But we are not buying a term plan so that we can invest the rest to get a return.
We buy term insurance because it is the most affordable way to be fully covered. In this regard, I have written a comprehensive guide (e-book) to insurance planning and you can download it for free at advice.moneyowl.com.sg to understand more.
Since 2003, I have been writing about using term plans instead of expensive whole life plans for protection. For that, I have drawn flak from advisers. But why am I so conscious about lowering the cost of insurance?
It is because we do not plan our insurance needs in isolation from our total financial planning needs. We all have limited financial resources but unlimited needs and wants.
As an adviser, I need to ensure that after the insurance needs are taken care of, I leave enough money for clients to plan towards their other areas of needs such as retirement and funding their children's tertiary education - and still leave enough money to live life now.
Because life does not begin at retirement. Life begins today. Financial planning is not just about planning for the future, it is also about making sure we can live a meaningful life now.
• The writer is chief executive of Providend, a fee-only retirement financial adviser, and also executive director of MoneyOwl, Singapore's first bionic financial adviser.
