Life insurance is one of the most overlooked aspects of personal finance despite protection being one of the 5 pillars of personal finance. There are a lot of reasons people don’t purchase life insurance and one of the main ones is the perception that life insurance is expensive. However, buying term products and investing the difference (BTID) is a strategy that everyone should be able to fit in their budget.
BTID is when you buy low-cost term insurance instead of a higher cost permanent policy. You then invest the money you save from lower monthly premiums into low-cost exchange traded funds (ETFs). This is one of the best strategies to optimize both the protection you have for your beneficiaries in case you die, while also building your portfolio.
How does the BTID strategy work and is it right for you?
Term Insurance vs. Permanent Insurance
Term insurance is a life insurance product that has a maturity date. If you buy a 20-year term policy and you don’t die over the next 20 years, your policy essentially expires. Since the insurance company may not have to pay a death claim on your policy, they are able to offer you a significantly lower price for the coverage.
[Professor B.T. Effer Note – Technically, you likely have the option to use post-level term to extend coverage. However, it costs much higher premiums to renew.]
This is different than a permanent life insurance product which has no maturity. As long as you pay your premiums, the insurance company has to pay a claim when you eventually die. The result is a much higher premium expense for you to pay.
Additionally, permanent insurance has a cash value. The cash value is an account within your policy that grows and is funded with a portion of the premium you pay.
There are dozens of different types of permanent life coverage. Some of the most popular type of permanent insurance are:
- Whole Life Insurance (WL)
- Guaranteed Universal Life Insurance (GUL)
- Variable Universal Life Insurance (VUL)
- Indexed Universal Life Insurance (IUL)
- Variable Life Insurance (VL)
All the different types of permanent insurance will cover you until you die. The nuances of the different types are out of scope for this post, but it is good to be familiar with the names.
How Term Insurance Works
When you buy a term insurance policy you elect a period on your policy and the amount of coverage you want. Standard term policy lengths are 10 years, 15 years, 20 years, and 30 years. Although other lengths are available. During the period you select, you generally pay a flat premium to the insurer every year. If you die before the policy matures, the insurance company will pay your coverage amount out to the beneficiary you elect.
It is a basic type of insurance. And there is a real chance you outlive your policy. This makes it very affordable.
Typically, a term policy costs magnitudes less than a permanent policy. Most permanent policies will cost 5-15x as much as a term for the same insured.
What is the Underwriting Process?
The underwriting process is when the insurance company reviews your application and denies or approves your coverage. Additionally, they will place you in a risk class based on your results. The better your risk class, the healthier you are & less likely you are to die, which results in a lower premium cost to you.
Most term insurance still requires an applicant to go through the underwriting process. Traditionally, this involved seeing a nurse and getting measurements taken & blood drawn for testing as well as answering a health questionnaire. You then need to wait for the insurance company to get the results of your test and review your case. In many situations, this can take 60-90 days from when you first apply to when you get an approve or deny decision.
Today, many companies have a simplified underwriting term product available. This skips the step of seeing a healthcare provider. The policy is issued based on the health questionnaire and the insurance company gathering your medical records. You can receive a quicker decision under the simplified process. Many products having the ability to be issued the same day.
[Professor B.T. Effer Note – Even though the full underwriting process can be inconvenient, it generally will provide lower premiums for you.]
What Options Are Available to Extend a Term Policy?
One of the main complaints about a term policy is the low chance of death during the term period. People view this as paying premiums and getting no return on the money. Many term products do come with options to continue your coverage after the term period is scheduled to end. These option are often not well known.
- Conversion Riders – Term conversion riders give you the option to convert your term policy into a permanent policy. When you elect to convert, you can get up to the same death benefit amount. However, note that permanent products are 5-15x more expensive. Therefore when you convert your premiums will significantly increase
- Post-level Term Period – The post-level term period give you the option of continuing to elect a 1-year term product after your level-pay period. If you buy a 20-year term policy, starting in year 21 you could pay increasing premiums on 1-year term.
It is important to understand your life insurance policy and what options are available to you.
Term Insurance Prices
Term insurance is going to be your cheapest life insurance option. As shown below, the price of a term policy is well within the budget of almost everyone.
A young and healthy 25-year old can get $500k of term insurance coverage for under $25 a month, that is the price of a single meal.
Term premiums increase the more likely you are to die during the coverage period. Therefore, premiums will be higher when you open a policy and:
- Are older
- Are less healthy
- Elect a longer coverage period
If we assume that a permanent policy costs 10x as much, that would be $250 a month for a similar $500k face coverage for the 25-year old. Then your 2 options would be:
- Pay $250 a month into a permanent policy and get a low after-fee return on the account value, or
- Pay $25 a month into a term policy and invest the $225 difference into low-cost ETFs to get the market return
Note on Term vs Permanent Insurance
[Professor B.T. Effer Note – There are reasons to get a permanent policy especially as part of a broader, tax-efficient estate strategy. However, permanent insurance does add a relatively high monthly fixed cost. So if you are on a tight budget, term is probably a better option.
There has been a move towards demonizing all permanent insurance. Personal finance gurus are calling it a scam. This is partly due to advisors pushing it for the higher commissions, sometimes at the detriment to their client. And partly it is due to ignorance by the guru (insurance is complicated). However, there is nothing inherently wrong or a ‘scam’ about permanent insurance. And we would avoid anyone who calls it a scam as it shows they are shallow thinkers.
Permanent insurance is just another tool. If you try to unsuccessfully hammer a nail with a saw, would you call saws a scam? Would you trust a handyman who tells you to never buy a saw because saws are scams? Same energy as people calling permanent insurance a scam.]
Invest the Difference – The Key To BTID
Continuing the example from above, you buy a term policy for $25 and invest the $225 difference into low-cost ETFs. You are making monthly contributions into assets that will grow over time. If you assume a permanent insurance returns 4% on your premiums after-fees & after-charges. And assume your low-cost ETF returns 8%, then after the 20 year term period the difference is stark.
[Professor B.T. Effer Note – Vanguard was the original low-cost ETF creator. There are many other options now as well. You should be able to find broad market ETFs for under 0.1% expense ratios.]
In the simple illustration, we ignore that much of permanent insurance’s charges are front loaded. The actual cash value growth will look different in real-life. Each policy has a very unique account value growth pattern. But if the average return is around 4% over a long-period, the ending value in year 20 will be similar.
It is also important to note that at year 20 (month 240), you will still have $500k of life insurance coverage with the permanent insurance but would have no coverage with the BTID strategy.
You can see that BTID results in a lower monthly fixed costs and a higher potential portfolio value.
The biggest issue people run into is when they buy term and waste the difference. You need to actual invest the difference for this to work. If you aren’t investing, your aren’t doing BTID.
If you aren’t investing the excess $225 you are going to be worse off than purchasing a permanent policy. Even if permanent insurance returns are relatively low, it is a way to force savings for many people.
The Final Word – Buy Term & Invest The Difference (BTID)
Having life insurance is a key component of the protection pillar for your personal financial portfolio. It is vital if you have dependents. Term insurance is the cheapest way to get life coverage. If you invest the money you save from buying term over permanent insurance, you can build a significant portfolio over the life of the policy.
However, the BTID strategy only works if you actually invest the difference.
If you want lifetime insurance coverage or a way to force savings, you have the option to purchase permanent insurance. The cost of permanent insurance does tend to be significantly higher though.
Additionally, there is no limit on the number of policies you own. You can buy a smaller permanent policy and stack term policies on top. This is actually what we have done as part of our term ladder strategy.
At the end of the day, the decision comes down to what works best for you and fits into your long-term personal financial strategy.
A Buy Term & Invest the Difference (BTID) strategy involves buying a term policy for low monthly premiums and investing the money saved. Term insurance cost significantly less than permanent insurance. Often permanent insurance costs 5-15x more than a term policy. The premium you save is invested in low-cost exchange traded funds (ETFs) to grow your portfolio.
Everyone with dependents should have life insurance coverage to protect their loved ones in case of an unexpected death. Term insurance is one of the cheapest options to get life insurance coverage.
When you buy a term policy, you can invest the money saved over purchasing a permanent policy. Permanent policies typically are 5-15x more expensive. The returns on a low-cost exchange traded fund (ETF) have historically outperformed the returns on a permanent policy. Therefore, you get life insurance protection for your loved ones and are able to grow your portfolio and overall wealth.
Term insurance is a life insurance policy with a maturity date. In general, if you don’t die before the term policy matures, you don’t get any benefit payments on the policy.
Permanent insurance never matures and if you pay your premiums, your surviving dependents will receive a benefit on your death.
Since term policies may not pay out a death benefit, the insurance company is able to offer you a much lower premium. Typically a term policy will cost 5-15x less than a permanent policy.
Underwriting is the process of the insurance company reviewing your application and assigning you to a risk class. The better your risk class, the lower your premiums.
Full underwriting typically involves answering a health questionnaire and seeing a medical provider to take measurements and draw blood. It can take 60-90+ days to receive a decision and get your final premium price as a human will have to wait for the results from your tests and review all your information.
Simplified underwriting typically uses only a health questionnaire and access to your medical records to make a decision. Many simplified underwriting products can give a decision as quick as the same day. The process is largely done using an algorithm to place you into a risk class.