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Cash value and life insurance policies

A function of whole life plans

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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