How To Maximize Cash Value in Your Whole Life Policy

Whole Life Insurance is the original permanent life insurance product that builds cash value.  Before whole life insurance existed, life insurance was something that was leased on a yearly basis and every year the lease payment, or premium, increased because the risk that the insurance company would have to pay out a death benefit became more probable.  Whole life insurance eliminated that ever-increasing lease payment by establishing a fixed premium for the whole life of the insured, and thus the name whole life insurance was born.  Whole life insurance, allowed someone to own their own death benefit…rather than the insurance company owning it. And because someone besides the insurance company can own the death benefit with whole life insurance, equity can be established in the policy. This is similar to owning your own home…you can develop equity in the home.

In fixing a premium for the entire lifetime of the insured, whole life insurance also made it possible for equity to build up in the whole life insurance policy.  Equity in whole life insurance is called paid-up insurance and because this insurance is totally paid for, it has a cash value. This value is similar to the value that builds up in any other kind of asset that you purchase over time, in that the more you pay beyond the base payment required, the greater value you own of that asset.  In whole life insurance, the paid-up insurance cash value can be leveraged, withdrawn or used to pay premiums, much like the equity owned in real estate can be leveraged, sold or used.

Until the late 1980’s, when congress passed some new laws limiting the purchase of paid-up life insurance, paid-up insurance could be purchased at will, much like paying off a house faster than the amortization schedule or even paying cash up front. However, these new laws greatly restricted the financial feasibility of purchasing large amounts of paid-up insurance. This was done so the IRS could tax the cash value build-up that occurs if it is generated faster than what these new laws stipulate. A life insurance policy that builds cash value faster than the IRS stipulates, or has more cash value in relation to the death benefit and premiums paid is taxed like a qualified plan, instead of being taxed in the more favorable way life insurance is taxed under the IRS code.

That being said, there are still ways to build cash values faster in a whole life insurance policy than by merely purchasing base premiums, just like extra payments can still be made on a real estate purchase even though the amortization schedule has a fixed amount required that has to be paid. With the use of Insurance riders, added amendments to the life insurance contract, the owner can segregate the premiums paid into different channels permitting a policy owner to build cash value faster than simply by paying the required base premium. Using these riders can prove quite beneficial as a long-term financial tool because of the favorable

tax treatment the IRS provides life insurance proceeds, withdrawals, and policy loans. And many insurance companies still pay dividends on the entire amount of paid-up insurance, even though it has been leveraged.  (Withdrawals don’t earn any dividends as they have basically been surrendered and you no longer own that paid-up insurance once it is surrendered.)  Some of these riders are very practical and beneficial, while others can be costly and cumbersome to the policy owner, especially if they intend to leverage those cash values as soon as possible for another investment, transferring debt or for business purposes.  Therefore, even though you can still build up cash values fairly rapidly with certain riders attached to a whole life policy, it may not be in your best interest, depending on what you intend to do with those cash values.

Take for example illustration 1 compared to illustration 2.  In Illustration 1, only the base insurance is being paid and as you can see the cash values are significantly lower than in illustration 2 where a paid-up insurance rider has been attached and paid for in accordance to the IRS maximum allowed.  If you take the cash value in Illustration 2 and subtract it from the premium paid ($1,233), the balance is less than the base premium in Illustration 1 and the death benefit value is greater in Illustration 2 as well.

Now examine Illustration 3.  In this illustration, a term rider was

added for the first 15 years so more premiums could be put into the policy. But in year 16, notice the death benefit drops because the term rider that artificially propped up the death benefit, allowing more premiums to be paid in the first 15 years, becomes too costly to maintain. Therefore, Illustration 3 has allowed $55,247 of premiums to be put into the policy but only $64,774 of cash value has been built up (17.24% more than premiums paid) over those first 15 years compared to Illustration 2 where $59,507 of premium has been put into the policy and $73,188 of cash values have been created (22.99% more than premiums paid.)  This marked difference between Illustration 2 and 3 is entirely due to a portion of the premium paid being allotted to purchase the term insurance rider over the first 15 years. The extra cost paid for this term insurance rider has not been available to purchase paid-up additional insurance, therefore the cash values are lower in Illustration 3 than in Illustration 2. (Illustration 3 uses a one-year renewable term rider while some companies use a fixed level term rider.  Either term rider will have a cost that has to be paid which detracts from the premiums that could have been spent on paid-up insurance.)

Finally, notice that in Illustration 1 it takes 14 years to produce more cash value than what has been paid into the policy, whereas in Illustration 2 it only takes 7 years to produce more value than what has been paid. The paid-up insurance rider has cut in half the time it takes to produce more cash value than premiums paid in Illustration 2.  Illustration 3 adds another 2 years (until year 9) before cash values exceed the premiums paid, again because of the cost being paid for the term rider that was added to the whole life policy in this illustration.

Of course, nothing prevents one from paying extra premiums above and beyond the base and paid-up rider premiums, the only consequence is that the cash value loses its tax-preferred usage which the life insurance policy provides when doing so.  But, in some instances, it still makes sense to fund a whole life insurance policy with as much money as you can afford and are comfortable paying, simply because in doing so a larger tax-free death benefit is provided for your beneficiaries. As an estate planning tool, paying these extra premiums and ignoring the tax liabilities surrounding the cash value usage, one can pass on a considerable amount of tax-free inheritance to a corporation, family members or another beneficiary chosen.

The design of a whole life policy illustration should take into account the purpose for which you plan to use the policy. Your purpose for the policy will guide you in whether or not the use of riders is beneficial for your policy. Realize that each of these riders will affect the amount of death benefit and paid-up insurance you have as well as how much cash value develops and the tax treatment your policy would be subject to. Without understanding the outcomes that each of these provides it is impossible to determine how you should structure or allocate the premium payments you pay into your whole life insurance policy.

Don’t be compelled to purchase any life insurance policy until you understand the effect each rider attached will have on the policy you want to purchase.

If you do not understand the explanations of your agent or you are not confident of the proposal, you are welcome to have us review your illustration. We offer this service to make sure that you are getting the most affordable policy possible. You want to pay a premium that is comfortable and affordable for you, which means it will be sustainable. And you want to get the results that you are expecting in the future from your policy. It will be easier to have this discussion now, rather than later.