I will be discussing the difference between utilizing term and permanent life insurance for short and long-term needs with the assumption the reader understands the difference between the two types of coverage.
Short and Long-term Debt
When deciding to purchase a life insurance policy, it’s just as important to delegate each item as a short or long-term need, as it is to figure the total coverage.
Short-term needs are typically covered with a life insurance policy that matches the duration of the debt you wish to fulfill if you were to pass.
For instance, if you purchase a home with a 30-year fixed mortgage, you would purchase a 30-year short-term life insurance policy. At the end of 30-years, you’re mortgage will be paid off, and the short-term coverage will end, as there’s no longer a need for it. This is known as term life insurance.
Long-term needs are those lasting a lifetime. Some examples would be burial expense, inheritance for children and family, income to replace retirement income such as a pension or social security, or inheritance tax. This is known as permanent life insurance.
What percentage of my needs are short versus long
The majority of your needs will be short-term. Mortgage, car loans, credit card debt, student loans, are all examples of short-term needs. On average, ~70% of the average household’s debt will be short-term.
The remaining ~30% falls to long-term needs; final expenses, inheritance, current and/or retirement income including pension and social security, and inheritance taxes.
Buying term only
You could purchase a term policy to cover both your short and long-term needs. The only issue, is that when the coverage ends, 30% of your total needs will be left with no coverage.
You could buy another term policy at that time, and then again 30 years later, although, this would become cost prohibitive as the cost of insurance increases with age, but more importantly, the risk of declining health will lead to significant price hikes.
Buying term and permanent
Another option is to buy a term policy with a coverage amount equal to your short-term needs, and a permanent policy to cover your long-term needs. When the term expires, 70% of all debt is paid, leaving the permanent life policy to cover the remaining 30% long-term needs.
The pros here are a reduced cost of insurance when compared to buying a new term at expiration, it also guarantees against prices hikes due to declining health, however, the cost is higher in the earlier years.
Buying term and investing the rest
The final option is to buy a term policy, and setup and investment account to house the difference of what you would pay for a permanent policy, with the hope that account value will be equal to your long-term needs by the time the term policy expires.
The biggest issue with “buying term and investing the rest” is that researchers have found that most people don’t invest the rest, in fact they spend the rest, leaving them in a position where they have no life insurance and no asset to help pay off any of those long-term debts.
Although buying term and investing the rest is the more affordable option, it’s the worst option for those who do not have the discipline to save the difference.
This is NOT a cash value life insurance versus term invest the rest comparison
Keep in mind, this article is not meant to compare buying a term policy and investing the rest versus buying a cash value life insurance policy. You can read more on that here.
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