Click here to access Buy Term, Invest the Rest? (BTIR) – The Ultimate Insurance Guide for Beginners (Part 2)!
Earlier this year, I met up with my financial consultant (a.k.a insurance agent) on the various insurance coverage that I needed. The only protection that I had was a H&S plan. She recommended that everyone should at least have a whole life plan which will allow you to take back part of your paid premiums.
Before committing to anything, I continued to do more reading regarding the importance of insurance and the types of insurance that were available on the market. There are a few websites that compare the different insurance plans and their prices so that consumers can make an informed choice based on their needs. It is needless to say that through my research, I have also learnt about the concept of “Buy Term, Invest the Rest” and how everyone seems to be raving about it. My real concern was if this was a feasible approach and was it really that easy to implement.
Let me do a quick summary about my findings.
Basically, there are two main types of insurance, namely life insurance and term insurance.
Within life insurance, there are a few types of insurance plans. Whole life, endowment plans and Investment-Linked Policies (ILPs) are all part of life insurance. All of them work similarly but for this article, I’ll focus only on whole life. Whole life insurance plans come with two components.
The first component would be a guaranteed sum of benefit for a certain purpose (e.g. Death, Total Permanent Disability (TPD), Critical Illness, etc.) up to a specified age. Usually, this age is minimally 65, because this is the expected age that you will no longer have too many financial liabilities in your life and therefore require less insurance protection. As the policy holder, you would have to pay for your premiums until that age.
The second component of your life insurance steps in after you have crossed the age in the first component. Now, your life insurance will have both a guaranteed sum and a non-guaranteed sum. However, take note that this new guaranteed sum will be an amount that is much lesser than your initial coverage. The non-guaranteed sum, on the other hand, is subjected to investment risk and pays out typically 3% to 5% in terms of returns. This means that you can take back part of the premiums that you have paid for.
Term insurance is easier to understand. To put it simply, it is actually just whole life insurance but without the second component that is mentioned in the previous paragraph. Term insurance purely consists of insurance coverage. There is no money used in your premiums for investment purposes. Therefore, for the same amount of coverage, it is most likely that you pay much lesser premiums than what you would pay for whole life insurance.
Here is a flow chart for easy visualization:
That’s all you need to know about insurance for now. Simple, isn’t it? 😉
Now, back to BTIR.
The idea of Buy Term, Invest the Rest is to buy a term plan that would be able to provide the same coverage as a whole life plan, and use the difference in the premiums to do your own investment that may eventually generate better returns over the entire period of your insurance plan.
Let’s see how this pans out in reality.
1. I am a female and non-smoker.
2. I am 30 years old this year.
3. For Whole Life insurance:
My premium term is up to Age 65. Since I am 30 years old, I will pay an annual premium of $5,500 for 35 years.
I have a Death/TPD benefit of $300,000 until I am 65.
Upon crossing the Age of 65, I am assured a guaranteed sum of $50,000 and a non-guaranteed sum of $162,000 with a projected annual return of 4.75%.
4. For Term insurance:
My premium term is up to Age 65. Since I am 30 years old, I will pay an annual premium of $800 for 35 years.
I have a Death/TPD benefit of $300,000 until I am 65.
From the above comparison between the two insurance plans, your goal is to make sure that by Age 65, you are able to get a return of at least $212,000 ($50,000 + $162,000) from your own investments using the difference in the premiums paid. Keep this number in mind.
Here are the calculations. Access the free spreadsheet here.
The cell highlighted in yellow is the final amount that needs to be more than $212,000.
Wait wait wait, scroll up again. What did you see? An investment portfolio which yields 1.37% annually?!
Nope, you don’t need new glasses, if that’s what you’re wondering.
That’s right. You only need a compounded annual yield of 1.37% should you choose to get term insurance instead.
Do you know what does 1.37% mean? You can essentially take the difference and dump it into Singapore Savings Bonds for 2+% annualized returns, with higher liquidity. Or even just voluntary contribute the money to your CPF OA account at 2.5%, get tax relief for it, and still get a higher return!
This is when you’ll be beside me exclaiming, “HUH!? What happened to the 4.75%?!”
Well, you know insurance agents get a commission from your premiums, right? There are also distribution costs involved. If the insurance company takes your funds to invest in their own mutual funds, then another part of it will go to the fund manager. All these expenses eat into your final profits, therefore giving you much lesser returns than 4.75%.
You should bear in mind that this is a simple analysis. There are other things that I did not consider, and the assumptions may not necessary fit your situation. One example is that since my starting age is 30 years old, I have more time to compound my returns. The results will be drastically different if you started the plan when you are Age 40 – the annualized yield would change from 1.37% to 4.29%. In this case, buying the whole life plan may not seem to be such a bad idea.
Remember, the more time you have, the more advantageous this strategy will be.
Take note that there are both whole life and term plans existing now in the market that allow you to extend the coverage up to Age 99. For whole life, you can also decide on how long you would want to pay the premiums for. Of course, if you opt for a shorter period of time, then your monthly/yearly premiums will also increase as accordingly.
Additional riders such as Critical Illness coverage may also be cheaper if you bundle it together with a whole life plan. It seems that riders for term plans tend to be more expensive; sometimes the premiums for the riders may be even more costly than the original premiums.
If you are still interested on this topic, try reading these articles to gain some more insight:
For a continuation of this topic and what I did get for my insurance coverage, stay tuned for Part 2 that would be published in tomorrow’s daily blog post!
Thanks for reading!
Miss Niao xoxo