My friend Brandon is a very big advocate of Permanent Life Insurance. Him and I have gone the rounds on many occasions about permanent versus term. I decided that to be fair, I would present his argument in a series of posts here in Rabbit Funds. The series begins with a post about challenging the pre-conceptions about permanent life insurance. You can find links to the other posts in the series at the bottom.
The biggest thing that is left out of the mix when buy term and invest the difference comes up is how to actually spend the money. Sounds funny right? How many of us need help spending money?
If you opt for this strategy, then likely this is the only financial asset you may have when either retirement or death comes around. Maybe there will be a pension or social security to help out or maybe there won’t be. Either way, the nest egg will need to be very well taken care of because it has to provide an income for the rest of your life. And no one has any idea how long that will be.
Typically when someone gets to this point, the most popular option is to live off the interest, which might not sound so bad.
But here is the reality: when someone only has a nest egg to survive on, they have broken one of the number one rules of investing: diversification. The result is that this nest egg has a lot of pressure on it. It must provide an income, keep up with inflation, pay taxes, pay for the new car and the trips, and so on.
To accomplish all of this, the money must be left exposed to the market in order to attempt to grow. This is the kind of thing that will keep you up at night. Imagine being in this situation, desperately needing this money to survive, and watching the market take a tumble.
How much stress has just been added to your life?
If you visit a financial planner, you will be told that you can plan to spend about 4% a year from your nest egg if you are living off the interest. This is a conservative number, one that gives the greatest likelihood that the money will stay intact for the full time it is needed.
Let’s say that you have $500,000 in your nest egg. Four percent of that is $20,000. After you pay taxes, you are down to around $15,000 per year to spend. Will you be ok with that? Maybe, if you did actually manage to pay off all of your debts. But how many people will actually want to live on that kind of money? And don’t forget to factor in inflation; that $15,000 per year is in today’s dollars.
If you think it would be hard to live off of that money now, imagine what it will be like in 30 years. If we experience only 2% inflation, which is much lower than what is actually expected to happen, that $15,000 will only have about $8,200 of buying power in 30 years. You better hope that someone steps in, because all of a sudden things aren’t looking so good.
There are some very powerful spending strategies for retirement that require permanent insurance, strategies that will allow an individual to experience less risk, spend more money, and overall have more peace of mind in retirement.
So all things considered, buying term and investing the difference might not be all it’s cracked up to be.
But the talking heads don’t tell you this, they just pitch the idea. It’s up to you to understand the implications of your decisions and do what is best for you and yours. Ultimately, it’s not a bad idea to start with term insurance and put away as much money as you can for your future. After all, the more money you put away, the more you are likely to have.
But before you lock yourself into a strategy that you don’t fully understand, do some research or talk to a professional about your situation and see if there are some better strategies or ideas that will be in line with your goals. After all, we all want more or less the same things financially: stability and freedom. There are many different routes to take, just put in the effort on your part to make sure your path leads you as close to your goals as possible.
Here are all of the posts in this series:
- Challenging Pre-conceptions
- How Term Life Insurance Works
- Is 12% Realistic when “Investing the Difference”
- Returns, taxes, death benefit and debt
- Achieving Financial and Spending Freedom
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