Term vs. Whole Life Insurance

Life insurance will cover the mortgage if anything happens.

Two years ago, after purchasing our house, wifey and I looked into getting life insurance instead of mortgage insurance. Not knowing the differences between Term and Whole Life, we got a product with 50/50 mix of Term and Whole Life. Our broker advised against Whole Life, but suggested we mix the product 50/50. I wish I listened to him then.

As I've become more financially adept, I've come to realize that Term Life insurance isn't a rip-off or a waste of money.

Let me first explain what Term Life is. It's insurance for a set amount of years. You pay a premium each month during the term. If you die during the term, the insurance company will pay your beneficiary the amount insured. If you are still alive when the term ends, you are no longer covered.

This is where I thought Term Life was a waste of money. After 20 years of paying a monthly premium, I thought the money would be wasted if I didn't die while I was covered by the policy. However, I read an argument that made me realize my folly. Would it be a waste of money to buy fire insurance if your house never burns down? What about flood insurance if your basement never floods? Likely not, as it would be expensive to replace everything without insurance. In this case, Term Life insurance covers your beneficiary in case something happens to you.

This is not to say Whole Life is a bad insurance product. Whole Life is the same as Term Life except it contains a saving component. As far as I understand, this product is good for helping people save money and benefits upon death are paid out tax free. Unlike Term Life, the policy doesn't expire and payments are reduced in later years as the cash value of the savings increases.

The money placed in the savings component is actively managed. This means the amount incurs high MERs. Additionally, while the target of the yearly growth is set, it's not guaranteed. Any growth beyond the target growth is profit for the insurance company. So if the target is 6% and the investments go up 15%, the insurance company keeps the extra 9%.

The problem for wifey and I is that we are savers. So investing in Whole Life doesn't make any sense for us.

After 20 years, the dent in the mortgage should be significant and the finances should be in a good spot. If something happened after the term ended, the amount in investments and savings should more than cover the remaining amount in a mortgage.

Since I'm gunning for early retirement, we contacted our broker and had him cancel our current plan and look into a new Term 20 plan. Before, we were paying 5% of our income a month for coverage. Now, we're going to be paying 1% a month, or a savings of 4% a month.

Now we need to bank these savings into a registered plan (RRSP or TFSA), otherwise saving an extra 4% doesn't do us any good if we're spending it.

Over the next 20 years, this will save us 960% of our net monthly income (4% x 20 years x 12 months) or 80% of our net yearly income. With the target savings rate of about 33%, that means we'll be working at least 1 year less. That's on a 4% savings. Imagine what else if possible if I can find more savings elsewhere.

By this time, our mortgage should be on its last legs (a few more years) and we should be retired so we won't need the life insurance any longer.