Term Life Insurance (1) : Using Term Life for a Bequest – Is it worth it?
Leaving a bequest for our loved ones is a key goal in retirement, but it is not easy to balance between retirement spending and the savings required for a bequest. With Term Life Insurance now being offered up to 99 years of age, a new tool for structuring a bequest is now available. But not all Term Life Insurance policies are the same. In the case of a 50-year old man hoping to leave a bequest of $500,000, getting the right insurance policy could make him $60,000 better off, while getting the wrong policy would leave him $45,000 poorer. How do we choose from the Term Life Insurance policies out there?
In a discussion on the topic of life insurance, the debate is usually between whether Whole Life insurance or “Buy Term Life Insurance and Invest the Rest” is better. Indeed, our blogposts here and here cover this debate as well. We show that “Buy Term Life” does as well as Whole Life in terms of insurance coverage. “Investing the Rest” usually does better in terms of investment returns too. In fact, for those nervous about investing on their own, putting the money saved from Whole Life premiums into the CPF Special Account which earns interest at 4% per year does just as well as a Whole Life fund.
Now that insurers are offering Term life policies which stretch to age 99, Term Life Insurance is no longer a poor cousin of Whole Life Insurance anymore. Term coverage can effectively be for life, so further eroding the selling point of Whole Life Insurance. This also means that we can explore using Term life Insurance to set up a bequest for our heirs too. So let’s look at this and see whether it is worth our while to do so.
Choosing the correct Term Life Insurance policy for a bequest can make you $60,000 richer. Choose the wrong one and you could be $45,000 poorer!
Using Term Life Insurance for a Bequest
How can we use Term Life Insurance to set up a bequest? Take the case of a 50 year old male, who uses Term Life Insurance to cover himself for $500,000 until the age of 100. Since most people don’t live so long, the insurance policy will pay out to his beneficiaries upon his passing, effectively leaving them an inheritance of $500,000 in the future. Neat, right? Moreover, the Term life Insurance comes in different flavours. He can choose to pay a premium every year until he passes. Or, he can opt for a limited pay policy, in which premiums are collected for only the first 5 years or 20 years of the term covered, giving him more flexible to make all the premium payments while still employed.
Looking at the comparison website comparefirst.sg, the quotes for Term Life Insurance from ages 50 to 100 in November 2019 are in the table below:
Term Life Insurance premiums for a 50 year old male until age 100
|Insurer||Coverage||Annual Premium||Years Payable||Total Premiums|
Just by looking at the premiums payable and the insurance payout, it appears that using Term Life Insurance will let you (or rather your heirs) get almost twice the amount you put into the policy. The best deal appears to be the limited pay option to pay all the premiums in 5 years. Des this sound like a good deal?
Not so fast! We all know that a dollar paid today is worth more than a dollar received in 20 years’ time. So paying premiums upfront for a Term Life Insurance policy is offset by the lower value of receiving the big payout much later. Let’s present value the premiums payable and compare them to the present value of the payout. But what discount rate to use? At the age of 50, we will have less than half our lives left to live. So our discount rates will be higher. Let’s use 4%, since this is a benchmark rate we use to discount our annuities like CPF Life.
Present Values of Term Life Insurance premiums & payouts
|Insurer||PV of Payout at age 100||Annual Premium||Years Payable||PV of Total Premiums|
Now things look a bit different! In all cases, the present value of the premiums paid is way higher than the present value of the payout! Which means that this looks like a bad deal. Also, the limited pay options end up being the worst now, with a far higher value in premiums paid compared to the ones which are paid annually until the end of the term.
But again, this is not the full story. Nobody lives till 100 except for the rare centenarian. The average life expectancy for a man in Singapore is 83 years. So, what if we assume that the person in question passes on at the age of 83, and hence only needs to pay premiums for 33 years? The table below shows the outcomes:
Present Values of Term Life Insurance premiums & payouts (33 years)
|Insurer||PV of Payout at age 83||Annual Premium||Years Payable||PV of 33 years of Premiums|
So finally, we see whether using Term Life Insurance to set up a bequest for our family is worthwhile. In short, it is only worthwhile if we take the option to pay premiums every year until we pass on. Any limited pay option really only benefits the people who opt for the yearly premium payments instead!
In fact, using the Singapore life expectancy tables, we can work out exactly how much we can benefit from using Term Life Insurance to set up a bequest:
Value of using Term Life Insurance for a bequest
|Insurer||Payout Amount||Annual Premium||Years Payable||Value|
Yes – buying the right Term life Insurance can make you $60,000 richer. But buying the wrong type can makes you $45,000 poorer! Paying premiums for the rest of your life may sound scary, especially if you run out of money when retired and have to lapse the policy. But it is more worthwhile. To avoid lapsing in the future, make sure you set side enough to cover the future premium payments before you retire.
Don’t use the wrong Term Life Insurance to set up a bequest! Never choose the limited pay option or you could end up much poorer! Just make sure you do not lapse the policy.
While these results use a discount rate of 4%, qualitatively the same results apply when using other lower discount rates. It is always better to pay premiums annually because there is a good chance of passing on before paying all the premiums!
Appendix: How to use life expectancies to work out value of Term Life Insurance
To derive the present value of Term Life Insurance, we start with the Life Table for Singapore Males:
|Age x (Years)||Prob of dying between age x and x+1||Number of survivors at age x||Number of deaths between age x and x+1||Expectation of life at age x|
From this table, we can compute the likelihood of a person surviving up a particular age by dividing the Number of Survivors at exact age x by the same number at an earlier age. For example, the chance that a 55-year old male will survive to the age of 90 is:
I90/I55 = 24,137/95,636 = 25.24%
To find the present value of a future payment at the age of 90 say, P90, we discount this payment for the time until the receipt of the payment. So for a 55 year old person, the value of this payment at the age of 90 (i.e. in 35 years time) is:
Present Value = P90 / (1 + Discount Rate)t
where t = 35 years, and Discount Rate = 4%. For a term life insurance policy, the premium payment at age 90 is only payable if the person survives until age 90. Hence, we need to further adjust this by the likelihood of this payment happening, which is 25.24% for a male, as computed earlier. In terms of the insurance payout, the likelihood of this being received (by the nominees, of course!) is the chance that the person survives until age 90 (which is 25.24%), multiplied by the chance that he/she then passes on in the same year q90, which is 14.73% from the life table above.
This calculation of the present value of the premium payable and the payout receivable is done for every age from the start date, and summed up. There is no double counting because all these premiums and payments in each year is weighted by the probability of it happening, based on the life expectancy at every age.
This computation is also described in the previous blogpost here.