Does Warren Buffett "Buy Term and Invest The Difference"?

“At bottom, any insurance policy is simply a promise, and as everyone knows, promises vary enormously in their quality.” — Warren Buffett, Berkshire Hathaway 2004 Annual Report

Free Promises
Some insurance is free

• Travel insurance with your credit card
• Extended warranties with your credit card
• Ontario Place rain-free guarantee
• 30 minutes or your pizza’s free guarantee

This is possible because the benefits are limited and claims are infrequent.

Term or Permanent?
With life insurance, term coverage costs less than permanent coverage for the same reasons as above. Term life is a gamble because death is unlikely during the period of coverage and because the steep premium increases at renewal encourage you to cancel coverage.

With permanent insurance, the tax-free death benefit will be paid as long as the coverage remains in force for life. Naturally, this stronger promise costs more. As long as you keep paying the premiums, the insurance company must provide coverage even if your health deteriorates.

Your chances of dying increase as you get older. Suppose you bought term coverage with rates that increased each year as you age. Do you see the problem? The insurance becomes increasingly expensive as life expectancy approaches. So you can’t afford insurance when it’s most likely to pay out. What good is that?

How The Government Helps
What’s the solution? Prefunding. To encourage Canadians to save for retirement, the government allows savings to grow tax deferred until withdrawals are made. Permanent life insurance gets the same advantage of tax deferred growth.

You maximize the benefits of compound growth by making large contributions as quickly as possible. This means that when insurance charges are deducted, part of the money comes from investment growth that was never taxed. In effect, the government is subsidizing the cost of your insurance.

The government isn’t crazy. As with RRSPs, there are limits on how much money you can invest. There’s much more flexibility, though. The maximum premium varies by age, gender and the face amount.

Surrender Values
If you decide you no longer need your permanent insurance, you can cancel your coverage and get a taxable cash surrender value. According to Warren Buffett, you’re probably giving up an excellent investment:

“Berkshire purchases life insurance policies from individuals and corporations who would otherwise surrender them for cash. As the new holder of the policies, we pay any premiums that become due and ultimately – when the original holder dies – collect the face value of the policies. The original policyholder is usually in good health when we purchase the policy. Still, the price we pay for it is always well above its cash surrender value.”
— Warren Buffett, Berkshire Hathaway 2004 Annual Report

Why Doesn't Everyone Know
If permanent insurance is so good, why would anyone “buy term and invest the difference”?

Universal life insurance, the predominant form of permanent insurance, combines term insurance with the tax deferred growth.

Online, most anyone can publish most anything without verification of facts. Wouldn’t you want to get other opinions? If you search using keywords like “buy term and invest the difference” you’ll find many articles on that alternative to permanent insurance. A good starting point is wikipedia. You won’t find consensus, though.

Using life insurance for tax planning requires specialized knowledge that few have. So teams are used (see The Financial TRAIL To Taming Your Financial Risks) with experts in risk (insurance), accounting, investments and law.


That’s why you won’t find many articles from external credible sources. Insiders know but they

• are perceived as biased
• guard their knowledge or lack ways to communicate them

As a result, the tax advantages disproportionately go to the wealthy and the general public doesn’t even know.

What's Right For You?
The answer depends on your age, health, gender, risk tolerance, time horizon and goals. A competent insurance specialist will fairly compare universal life against a conventional investment reflecting taxation and all other costs. You’ll want to compare investment growth and also estate values. The results may surprise you.

Links

• The perils of whole life insurance (new) 

The Financial TRAIL To Taming Your Financial Risks

Alone we can do so little; together we can do so much. --- Helen Keller

Accountants are the most trusted financial advisors. Unfortunately, they are rarely experts in how the tax advantages of life insurance can help their clients. That's fine because they were at least asking. That got me thinking, about the roles of different advisors in today's specialized world.

As time passes we all get better at blazing a trail through the thicket of advice. ---
Margot Bennett

Why The Weird Capitalization?
Your Financial TRAIL starts with Trust and relies on specialists in four areas:

1. Risk: measures and reduces financial risks (e.g., insurance advisor)
   
2. Accounting: tax planning, tax filing (e.g., accountant)
   
3. Investments: selects and manages investments (e.g., stock broker, mutual fund advisor)
   
4. Law: prepares and reviews documents (e.g., lawyer)
   
   
   

The Trusted Financial Advisor
One of these four --- typically your accountant --- is the trusted financial advisor, the one you consult before making an important decision. This happens most often in small businesses.

Many sports are based on teams. However, your specialists probably work separately, depriving you of the advantages of a true team.

The way a team plays as a whole determines its success. You may have the greatest bunch of individual stars in the world, but if they don't play together, the club won't be worth a dime. --- Babe Ruth