Buy term and invest the difference: a worksheet for your own numbers

Whether buying term and investing the savings beats whole life is a question about a particular household, not about the products in general. It turns on four numbers you can look up (two premiums and the whole life ledger), one you must assume (a range of investment returns), and one that no calculator can supply: whether you will actually make the deposits. This worksheet takes you through each in order. It does not declare a winner, because the honest result is usually a range that depends on your own inputs.

The pros and cons are laid out in the guide on buy term and invest the difference: does it hold up. Here the job is arithmetic. All figures in the worked example are hypothetical and chosen to keep the math clean; they are not quotes, prices or predictions of any market.

Before you start: gather five things

Pull these together first, and the rest takes about half an hour.

1. A real quote for the term policy you would buy: amount, length in years and monthly premium.
2. A real quote or illustration for the whole life policy with the same death benefit, from a comparable health class. Ask for the full ledger, with a guaranteed column and a non-guaranteed (projected) column.
3. The year when you expect to stop needing the coverage, or the length of the term, whichever you are testing.
4. Where the difference would go: an employer plan, an IRA, a taxable account. If an employer match is on offer, that changes the comparison before you start.
5. An honest answer to a behavioral question: in the last few years, have you kept up an automatic savings habit through lean months?

The buy term and invest the difference calculator will run the compounding for you. Doing it once by hand shows what drives the result.

Step 1: set the coverage need

Both sides of the comparison must insure the same thing. Settle the amount and the length first, using the How much life insurance do I need? if you have not. In the worked example, the household needs $500,000 of coverage for 20 years while the children are young and the mortgage is outstanding.

If part of your need lasts for life, for instance a dependent who will always need support, note it now. A term policy that expires does not meet that part, and the worksheet will show a gap for it later.

Step 2: enter the two premiums

Write down the monthly premium for each, at the same death benefit.

The example premiums are invented. Real premiums depend on your age, health class, the company and the product, and a quote for a healthy 35-year-old will not resemble one for a 50-year-old with a health history. Use real figures from the same underwriting class on both sides, because a comparison between a preferred term quote and a standard whole life quote is not a comparison.

If your whole life policy is participating, decide how you will treat dividends. For a fair test, use the guaranteed column in the base case and the projected column in a second case.

Step 3: choose a range of returns, not one number

You cannot know what your savings will earn, so test three levels that span what you consider plausible. Write them as annual rates, compounded monthly in the example below. Pick a low case that you could live with, a middle case and a high case. The example uses 3, 5 and 7 percent as a spread, not as forecasts. Past returns on diversified investments have varied widely from decade to decade, and no historical average is a promise.

The balance after a series of equal monthly deposits is the deposit times the factor ((1 plus i) to the power n, minus 1) divided by i, where i is the monthly rate and n is the number of deposits. You do not need to do this by hand, but it helps to see the result:

Run your own three cases in the calculator, or on paper with the formula, and write the results down. If you test a 30-year horizon, expect the balances to be far larger in the later years, because compounding does most of its work at the end.

Step 4: subtract the tax drag

The balances above ignore taxes. Money in an employer plan or a traditional IRA grows tax-deferred but is taxed on withdrawal. Money in a Roth account is taxed up front and not later, subject to the rules. Money in a taxable account is taxed on dividends, interest and realized gains along the way.

A rough way to test the effect is to subtract a percentage point or two from the return for the part of the money held in taxable form. In the example, suppose the 5 percent case loses one point to taxes each year, so it grows at 4 percent. The balance after 20 years of $300 a month is about $110,000 instead of about $123,300, a difference of about $13,300. Your own rate depends on your tax bracket, the account and the investment, and a tax professional can tell you what applies. This worksheet cannot.

For the whole life side, the cash value grows tax-deferred, and the death benefit is generally income-tax-free to a named beneficiary. Gains in the cash value are taxed if you surrender the policy and receive more than your basis. See how cash value is taxed: withdrawals, loans and surrenders for the mechanics. Write the after-tax figures next to the before-tax ones, and use the after-tax ones in the comparison.

Step 5: test the months you might miss

This is the step that most worksheets omit and that most often decides the outcome. The strategy only works if the difference is invested, and a bill that is optional is easier to skip than one that is not.

Suppose you invest every month for the first half of the 20 years and then deposit nothing for the second half. Or, as a simpler test, suppose you deposit only half as much on average, $150 a month, because some months you skip and some months you pay less.

Those figures are exactly half of the full-deposit balances, which is the point: the strategy delivers in proportion to the money that actually goes in. Enter your own estimate of how much of the difference you would really invest. If you have never kept an automatic habit, the honest answer might be lower than you hope. If you already max out a retirement plan every year, it may be 100 percent.

Whole life has the opposite shape. You pay the premium, or you let the policy lapse, and a lapse early in the policy's life usually costs you most of what you paid. The discipline is built in, and the price of a missed bill is higher. See life insurance surrender charges explained for the early-year cost.

Step 6: read the whole life ledger

Now turn to the other side. From the whole life illustration, copy the guaranteed cash value and the projected cash value for the same year as your investing horizon. Also write down the death benefit in that year.

In the worked example, suppose the ledger shows these values at year 20, both invented for the exercise:

Compare these with the investment balances from Steps 3 to 5. Three observations follow from the example.

First, the investment balance at 5 percent ($123,300 before tax, about $110,000 at 4 percent after the tax drag) is above the guaranteed cash value of $80,000 and comparable to the projected one. At 3 percent ($98,500) it is above the guaranteed value and below the projected one.

Second, a useful measure is the break-even return: the annual return the investor needs to match the whole life figure. To reach $80,000 in 20 years with $300 a month, the account needs about 1 percent a year. To reach $110,000, it needs about 4 percent a year. Those are the two thresholds that matter for this household. The first is a guaranteed bar, and the second depends on the dividend scale holding.

Third, and most important, the comparison is not yet fair. At year 20, the whole life holder still has $500,000 or more of coverage in force. The term buyer has the account balance and no coverage. Step 7 prices that difference.

Step 7: price the coverage the term buyer no longer has

When the term ends, the household either does not need coverage or does. If it does not need coverage, the account balance is the whole result, and the comparison is simple. If it does, the household must buy new coverage at an older age, or convert the term policy if it has a conversion right, or live without it.

Fill in the following lines.

If your need ends with the term, Line F is "no," and the later years of whole life are coverage you pay for and do not use, though they come with cash value you can use. If part of the need is lifelong, the term-and-invest plan needs a second leg, and Line H is the cost of that leg. The guide on term vs whole life insurance: which fits you discusses how the two designs differ in lifelong needs, and converting term life to permanent: how the conversion option works explains how a conversion works.

Step 8: put the results side by side

Now set the two outcomes next to each other for each case. Use a table like this and fill it with your own numbers.

In the worked example, the middle row says that an investor who deposits the full $300 gets roughly $110,000 to $123,000 depending on tax, and a whole life owner has between $80,000 guaranteed and $110,000 projected, plus continuing coverage. The bottom row says that an investor who deposits only half ends up with about $61,700 before tax, below even the guaranteed whole life value. Neither row names a winner. They name the conditions under which each approach comes out ahead.

Step 9: read the result honestly

A few patterns tend to appear when households run this exercise.

• If the need ends with the term, the deposits are made reliably and the return assumptions are not extreme, buy term and invest often compares well on cash. The comparison depends on discipline and on tax-advantaged room.
• If part of the need is lifelong, or the buyer would struggle to requalify for coverage later, the value of the whole life policy's continuing death benefit is hard to price. The cash comparison alone understates it.
• If the household is unlikely to invest the difference, the strategy's advantage shrinks or disappears, as Step 5 shows.
• If the projected whole life figures depend on a dividend scale that holds for twenty years, rerun the case with a lower scale. Ask the company or agent for that illustration. See guaranteed vs non-guaranteed values in a policy illustration.
• Cost is not the only consideration. Creditor protection, estate planning and the ability to borrow are reasons some households choose permanent coverage, and flexibility and liquidity are reasons others choose term and investing. The guide on whole life as an investment: what the returns really are covers the investment side of the argument.

A fee-only planner can run the same analysis with your tax situation and an employer plan in mind. This worksheet is a way to ask better questions, and it is not advice about what to buy.

Key takeaways

• The comparison rests on six inputs: two real premiums, the whole life ledger, a range of returns, the tax drag and the share of the difference you will really invest.
• In the worked example, $300 a month for 20 years totals $72,000, and the investor needs roughly 1 percent a year to match a $80,000 guaranteed cash value and roughly 4 percent to match a $110,000 projected one.
• Halve the deposits and the investment balance halves too, so the discipline question can decide the result more than the return does.
• At the end of the term the investor has no coverage while the whole life owner does; price the coverage gap on Lines F to J before comparing balances.
• Run the whole life side at the guaranteed column and at a lower dividend scale, and let a fee-only planner check the tax assumptions.