Life Insurance Cash Value: A Practical Discussion

by Peter Katt

As readers of my AAII articles know, I believe the best way to understand the maddeningly complicated life insurance asset is to present various anecdotes on specific issues.

In this spirit, several recent client encounters about aspects of life insurance cash value has prompted me to discuss cash values—not in a historical and comprehensive sense, but with narratives to provide a better practical understanding of cash valu

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Peter Katt CFP, LIC, is sole proprietor of Katt & Co., a fee-only life insurance advising firm located in Kalamazoo, Michigan (269/372-3497); www.peterkatt.com.


Discussion

J Deike from California posted 3 months ago:

Understanding life insurance is akin to explaining to an alligator that if he would climb a tree he could avoid drowning. What kind of tree you ask? Well, of course that depends. I give credit to the alligator for not caring in the first place. Besides, he’s more interested in finding his next meal and avoiding the shoe company entrepreneur.

The above doesn’t make sense you say? Kind of like insurance; my point exactly.


Subramania Jegathesan from Oklahoma posted 3 months ago:

Any life insurance is good ,only if you die. If you are disciplined , put the money in the market .at the end you will have more money and you are in control.life insurance is the worst form of investment. As I said it is good only if you die


Daniel Wickenhauser from Illinois posted 3 months ago:

Term life Insurance makes sense to cover a risk for a specific amount of time. Whole life insurance is just a bad investment, unless you will do nothing if not paying into your whole life policy. Sort of a forced savings, but not unlike overpaying the IRS so you can get money back...


G Gordon from Tennessee posted 3 months ago:

This discussion assumes the death benefit remains desirable. If I take the cash value out and cancel the policy, I have to pay income taxes on the cash value earned above the total of the premiums paid. With a 65 Life policy, over 30 years the cash value has increased at ~8% annualized, PRE-TAX. Not a bad investment.


Jerry Durham from Tennessee posted 3 months ago:

For at least 90-95% of the population, term insurance makes the most sense. I feel that the cash value in permanent life insurance is basically what you have overpaid for. In the words of A.L. Williams----"Buy term and invest the difference". Another problem with permanent insurance is that is it very difficult to figure out just what return you are making on your policy. Of course, that return is at the discretion of the insurance company, meaning that you have no control whatsoever.


Marvin Warren from Montana posted 3 months ago:

If I were given a dollar for every person who planned to "buy term and invest the difference" and didn't do it, and had to give back a dollar for everyone who planned to "buy term and invest the difference" and actually did it, I would be quite wealthy.

The AAII crowd is probably different, but the vast majority of families could really use a few hundred thou when somebody dies, and they are unlikely to be concerned about what the return on investment was.

Life insurance has it's place.


Allen Romain from Michigan posted 3 months ago:

term insurance claims are paid out on 2% of the polocies issued. if I could offer you a 98% ROI guaranteed you would take it all day long.Did it ever occur to any of you the life ins companies
started the buy term debate.It would certainly behoove them. Furthermore, look at all the wealth tranfer that does not take place due to prohibited premiums in our senior years.


Edmund Waller from Georgia posted 3 months ago:

Life insurance, especially whole life insurance, always gets a bad rap on investment discussion boards. I have had term life and "Comp Life" (a blend of whole life and term life insurance ) from NWM for the past 23 years. The Comp Life policies were acquired in pieces, over time, mostly by conversion of portions of the term policies, utilizing the conversion feature. The death benefit of the Comp Life policies are 7% of the total death benefit value of all insurance.

I have calculated the ROI for the Comp Life policies in a number of ways. First, I note that about two years worth of premiums for Comp Life pay the agent/company. Second, after the commissions are paid, the ROI on subsequent premiums is currently 4%, integrated over the past 23 years. This corresponds to a pre-tax ROI of about 5.5%. Not the best investment, but the beta for the cash value with respect to the SP500 is very low so that the cash value of the life insurance leavens out the volatility of my exposure to the stock market. At present, for someone about 14 years form retirement, the cash value of the life insurance represents about 18% of all my "retirement" savings. When I retire, it will still be about 18% of my "retirement" savings. As I spend down 457B and 403B accounts, the cash value of the life insurance policies will continue to increase, giving me a cushion of cash so that I will not outlive my savings if the markets performs worse than predicted over the next 20 years. For me, the cash value of life insurance becomes a buffer against excess volatility and down-side risk in the stock market and a way to transfer wealth to my children/grand children tax free.


Edmund Waller from Georgia posted 3 months ago:

Life insurance, especially whole life insurance, always gets a bad rap on investment discussion boards. I have had term life and "Comp Life" (a blend of whole life and term life insurance ) from NWM for the past 23 years. The Comp Life policies were acquired in pieces, over time, mostly by conversion of portions of the term policies, utilizing the conversion feature. The death benefit of the Comp Life policies are 7% of the total death benefit value of all insurance.

I have calculated the ROI for the Comp Life policies in a number of ways. First, I note that about two years worth of premiums for Comp Life pay the agent/company. Second, after the commissions are paid, the ROI on subsequent premiums is currently 4%, integrated over the past 23 years. This corresponds to a pre-tax ROI of about 5.5%. Not the best investment, but the beta for the cash value with respect to the SP500 is very low so that the cash value of the life insurance leavens out the volatility of my exposure to the stock market. At present, for someone about 14 years form retirement, the cash value of the life insurance represents about 18% of all my "retirement" savings. When I retire, it will still be about 18% of my "retirement" savings. As I spend down 457B and 403B accounts, the cash value of the life insurance policies will continue to increase, giving me a cushion of cash so that I will not outlive my savings if the markets performs worse than predicted over the next 20 years. For me, the cash value of life insurance becomes a buffer against excess volatility and down-side risk in the stock market and a way to transfer wealth to my children/grand children tax free.


Steve Daniels from Connecticut posted 3 months ago:

I have had a small whole life policy ($90K fixed death benefit)for almost 40 years now. I had been told that the annual dividend would pay the full premium in less than 10 years. That never happened. I still pay about $600 a year over the roughly $1000 dividend.

The cash value of the policy goes up about $2,000 a year and is now slightly over $53k. At a relatively healthy age 72, I am now trying to decide whether to continue the policy or take the cash value and invest it elsewhere. I really don't have a need for the insurance anymore (I just kept it thinking the dividend would pay the premium).

thoughts about whether it pays to keep it or not?


Charles H Wadhams from California posted 3 months ago:

Oh Dear; This discussion proves that Whole life insurance as a part of a total plan is very individual. all of you will argue the value of your securities, the relevance of your issues and the worth of bonds. That's what this organization is all about.
In consulting and selling Life insurance for 45 years, and managing agencies and teaching many individuals the business. I believe that there is a place for that whole life policy in my portfolio. and for the policy on my wife's life. we will always need the liquidity. At 87 and 84 we have done well and live well. the key is discipline! Buy term when you have a high risk, convert some of it as you grow, and invest all along. let the cash value be a bond portion and buy Value and growth securities.
As Peter Lynch taught; buy quality merchandise, in securities and in life insurance.
Charlie Wadhams BS, MSFS,CLU, ChFC.


Steven Sears from Iowa posted 3 months ago:

Back in the 1980s I bought a Universal Life policy that guaranteed 12% return. But with every statement the value was less and less. That was because the undisclosed and obscure fees totaled 15%. They even charged a fee for charging a fee. How do you think they pay for those skyscrapers downtown? None the less I have a Whole Life policy I have paid into since High School and is now worth much more than I have paid in. In our state every estate, no matter how small, is required to go through probate. That is our state government at work looking out for the little people. However Whole Life Insurance bypasses probate and is paid directly to the beneficiary at death.


John Annick from Connecticut posted 2 months ago:

When the cash value exceeds the value of the policy, should you cash it in and take the cash? Or when the insured dies, what total dollars would be paid to the beneficiary, the policy value or the cash value? I realize that the coverage would end in cashing in the policy.


Ken Owenby from Georgia posted 2 months ago:

Anyone who has ever been subjected to a pitch from a life insurance agent has heard about the wonder of "tax free" cash value loans (I can pretty much get a tax free loan from anyone -- my bank, credit union, brother-in-law, etc.) as though life insurance is some magical money making machine with no negative tax consequences. Thing is that the agents making the pitch never seem to mention that cash value loans, if not repaid, can cause a policy to collapse, as pointed out by the author of the article.

So to me this begs a question or two. First, If the purpose of life insurance is indeed to provide a death benefit -- as the author seems to contend, why not go with the simpler alternative -- an annual renewable term policy. True, term may get more expensive as one gets older. But I would say that anyone who could afford a whole life policy could also very well deal with premium increases for a term policy. Another poster points out that most term policies never pay a benefit. I would counter that's probably no big deal: the need for life insurance has ended and the policy holder has chosen to no longer buy it -- end of story. Secondly, acknowledging than unpaid cash value loans can negatively impact the policy, should not the "savvy" investor attempt to get some leverage out of cash value that is just sitting there. To the extent that the cash value is enough to pay the current year's insurance cost and/or fees, is there not an opportunity to take short term loans for purposes such as investment opportunities or even paying the premiums for other insurance products, such as LTC. This might be a good subject for a follow up article.

All in all the conclusion I always reach from these types of analysis is that the appropriate market for whole life is very narrow -- affluent individuals who have maxed out all other tax deferred/advantaged alternatives, have a real need for life insurance, and have large amounts of cash to dump into it into a broader estate planning tool.


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