Clearing the fog on life insurance cash value


Unlike term life insurance, which pays a death benefit if you die sometime within the policy’s term, permanent life insurance, such as whole life insures you no matter when you die, as long as you make the necessary premiums payments. Permanent life insurance features a “cash account” that builds value. The cash value is nothing more than a feature of a permanent policy in which your premium covers your death benefit, but the excess amount builds up cash to potentially be used for some things, including paying your premiums. Keep in mind that your cash value will be minimal in the first few years as most of your money is eaten up after the company deducts expenses, commissions to the agent, etc.

Let’s Assume that Lucy died, and she was the owner and insured of a $500,000 life insurance policy that had a cash value of $75,000. Lucy named Harry and Vickie as the beneficiaries of the policy. Do Harry and Vickie receive just the face amount of $500,000 or do they receive the face amount plus the cash value ($575,000)? Contrary to what many policy owners and beneficiaries understand, the cash value in any life insurance policy normally does not belong to the owner of the policy. Instead, it is an asset of the insurance company, which they use to pay the death claim. However, if Lucy’s policy is cancelled, the cash value in the policy belongs to Lucy under the terms of the policy’s “non-forfeiture” clause. Thus, in the above example, the beneficiaries forfeit the cash value and only receive the $500,000 death benefit. If you buy a permanent life insurance policy, and your agent tells you that your beneficiaries receive both the death benefit and cash value, they had better inform you that you would pay an additional fee for this privilege. Said another way; there is no free lunch.

As you might suspect it is normally a complete waste of money to accumulate a lot of cash value, only to have it go to the life insurance company when you die. You are 100% correct, which leads me to this sarcastic comment that I explain to permanent policy holders; “If you let me know when you will die, I will design your cash value life insurance policy to have one dollar of cash value on the day you pass away, thus saving you potentially thousands of dollars.” All kidding aside, dying with a large cash value is one of the biggest mistakes policy owners make, but nobody tells them any different. Of course, since nobody knows when one will die, it can be quite tricky to effectively manage the cash value. It is a bit of a balancing act.

If you are older, and you have a large amount of cash value that you probably will not touch, it could behoove you to consider using the cash value to purchase a paid-up policy with a higher death benefit. This way, you will provide your beneficiary with a larger death benefit, and your cash value will not go to waste. Other than not managing your cash value properly, there are four additional ways to cause havoc with your life insurance policy:

Not telling your beneficiaries that you have a life insurance policy(s).

Not naming the appropriate beneficiaries.

Not asking for an annual inforce illustration (see below.)

Repeatedly withdrawing money from the cash value of your life insurance policy.

How healthy is your life insurance policy? Cancelled

A permanent life insurance policy should never be purchased and shoved into a filing cabinet never to be looked at again. Quite the contrary, your policy should be monitored and managed on a regular basis. I recommend that one review their cash value policies annually by taking advantage of a complimentary “inforce illustration”, which is a snapshot of your insurance policy in its current position. Moreover, you will learn what you might expect in the future from your policy, both from a guaranteed and projected vantage point. Inforce illustrations are enormously essential tools for evaluating the performance of your policy over time.

Many policy owners are sitting on a ticking time bomb, and they do not know it. For various reasons, one’s policy may not be performing as expected. The concern is not so much the creditworthiness of the insurance company, but rather the annual premiums may not be sufficient to maintain the policy given the current economic environment. There are plenty of unfortunate and very sad stories where longtime policyholders receive an unexpected letter from their insurance company informing them that they must send in additional money to keep their policy in force. Regrettably, many of these unhappy policy owners have to cancel the policy (lose the death benefit) because they cannot afford the additional premium.

As you might expect, insurance companies defend themselves by saying that the terms of policy are “clearly” spelled out in the initial policy contract. In addition, they remind their policy owners that they mail a yearly statement that includes the premiums and the account value. According to results from many surveys policy owners do not read life insurance contracts. While it is certainly no justification or even a good excuse, policy owners buy life insurance, whether term or permanent, put it in a drawer and never hear from their agent again. It is paramount that you give your permanent life insurance policy (cash value) an annual check-up. The best way to accomplish this is with an in force illustration. Do not be afraid to call your agent and pepper them with questions. Moreover, do not quit until you are satisfied with the answers. You can always go directly to the service center of the insurance company. Bottom line; you must know the health of your life insurance policy.

Harry Pappas Jr., CFP®

Managing Director-Investments

Certified Estate and Trust Specialist

Pappas Wealth Management Group of Wells Fargo Advisors