If
you're
shopping for life insurance long
enough, you're bound to come across the
term cash value. It's typically a
function of how whole life insurance is
designed. As we discussed in our
whole life
insurance article, the cash value bell
and whistle may be just that but it's
important to dig a little deeper and
understand how it works and why it's a
part of life insurance policies at all.
Let's look closer at the cash value
component of whole life.
My
father-in-law was an old New York Life
agent right out of college. He's
been an insurance broker (now
independent) for more than 40 years now.
That's persistence! His daughter
(my wife)
has some small whole life insurance
policies that were taken out when she
was very young by her father. We
still get the statements which run
through the premium paid, life benefit,
and....whole life cash value.
She's had the policy for years (decades)
now and that cash value amount is not
that great. What is it and why is
it even there?
When
you buy a whole life policy, a small
percentage of your premium will go
towards your policies cash value which
is similar to an account you have within
you life policy. It is your asset
and you can even borrow against it.
If the amount becomes high enough, you
may be able to pay the premium with the
interest or dividend that this amount
earns. In our opinion, it amounts
to an expensive savings account built
right into your policy which begs the
question...why have it at all. Why
not charge less money for the
life
insurance premium and skip this whole
cash value step all together?
First, the cynical view. Whole
life insurance is quite a bit more
expensive than term life and people have
trouble departing with money. If
you can tell someone comparing life
insurance plans that some of the premium
will be given back to them in the form
of cash values accumulating in the
policy, it makes parting a little
easier. You can even say that at
some point in the future, the cash value
will high enough to pay the premium.
That sounds great when you sitting
around a table contemplating a very
large whole life insurance premium
payment. To some extent (here
comes the cynicism), why not reduce that
expensive premium payment and just let a
person invest or save the difference
themselves? That's wouldn't sell
many whole life policies, now would it.
Okay,
we'll assume all is right with the world
and look at any positives we can find
with the cash value concept.
Usually, you can borrow against cash
value for periods of time. You're
essentially borrowing from yourself and
paying interest to yourself but that's
how it's structured. The money
that accumulates is typically
tax-deferred. If a business
is paying the premium, these cash value
amounts borrow might not be subject to
tax but ultimately, the loan should be
paid back to keep the policy in good
standing. Indeed, the cash value
may one day be large enough to pay the
premium but so might separately invested
funds saved by
buying term life
and investing/saving the rest. The
argument seems to be whether the gain is
higher within the life insurance
company's control versus out (say
through your bank or investment
brokerage).
We
don't see how that's possible and we're
left with the fact that cash values,
dividends, and the like are just
different shades of lipstick on a pig.
People like to get something for money
they are paying and in our opinions,
cash values address this psychological
need more than a financial need.
If you absolutely need to have life
insurance for your entire life and
guarantee some benefit is paid to your
loved ones then whole life might be a
good fit. Just realize it comes at
a cost.
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