Consumers often mistake cash accumulation in life insurance for a money tree that they can either spend freely or leave to their family.
Unfortunately, there’s no such thing as free money, and neither of the above is true. Cash accumulation, or cash value, is not as straightforward as it might sound—we’d say it’s actually one of the main complexities that cause people to avoid buying life insurance altogether.
Not only that, those who do buy a policy with cash accumulation and don’t take the time to fully understand how the policy works, leave themselves and their families vulnerable to potential headaches down the road.
Read on to learn more about cash value in life insurance, including what happens to it when you die. The answer might surprise you.
Quick Article Guide
1. What is Cash Value in Life Insurance?
2. What Happens When You Borrow from Your Cash Value?
3. What Happens if You Save Your Cash Value?
4. What Can Happen if You Don’t Monitor Your Cash Value?
5. Investing with Life Insurance: Best Saved for the Ultra-Wealthy
6. Finding the Right Policy
Cash accumulation is the investment that comes with many whole life and universal life policies. Your “cash value” is held in a savings account that earns interest, separate from your face amount or death benefit, which is paid to your heirs upon your death.
What many people don’t realize is that cash value is an investment that—just like any other investment—carries a market risk. Meanwhile, unlike most other investments, cash accumulation in life insurance is not passed down to heirs.
By the end of this article you will realize that the money is not really yours in any way, shape, or form.
When agents tell you that you can borrow from your cash value to fund your children’s college education or your retirement, they’re not necessarily lying. However, there is generally no such thing as free money, and cash value in life insurance is no exception.
If you withdraw the cash value in your policy, the life insurance company considers it a loan. You will be charged a “cash surrender” fee of up to $750 dollars and will have to pay interest on the money you have withdrawn until the loan is paid back. It pretty much works the same as a bank loan or credit card.
Let’s say you die before you are able to repay the loan. The amount you borrowed would be subtracted from your death benefit, essentially leaving your family with less money than expected. If you tell your heirs that they will receive $100k from your life insurance policy after you die, but then you borrow $30k from your cash accumulation and die before you are able to pay the money back, your family will receive $70k. Many families end up underinsured at their loved one’s time of death for this very reason.
You might think that if you hold onto and grow your cash accumulation that your family would see an additional payout upon your death. We wish that were the case, but cash value in life insurance is not a death benefit.
If you die before you withdraw the cash value in your policy, your insurance company keeps the money. It is not paid out to your beneficiary or beneficiaries and is essentially lost.
If you want to leave investment money behind to your family, most experts will tell you to “buy term and invest the difference.” This refers to term life insurance, which is usually the more affordable choice, and suggests keeping your life insurance and investments separate. We’ve created an infographic comparing term life and whole life, and also frequently recommend guaranteed universal life insurance (GUL) as a non-cash accumulating hybrid of term life and universal life. Learn more about GUL here, and compare it to non-guaranteed universal life here.
There is a danger in cash accumulation, and it has to do with the market risk that most people don’t understand.
Big-box agents selling cash accumulation policies tend to downplay the real-life risk because they are trying to hit their sales quota, keep their job, make a living, and earn a commission. They’re not doing anything wrong, but they’re not properly educating you.
Your cash accumulation is used to pay your cost of insurance and mortality risk charges, which increase each year as you age. These charges are different from your premium, and often go unnoticed for years. The problem is that in an age of low interest rates, cash accumulation generally doesn’t perform well.
When your investment performs poorly and does not keep up with the cost of insurance and mortality risk charges, they can deplete your cash value down to zero. The charges then become out-of-pocket costs, at which point the same policy you were counting on for the past 20 years can become instantly unaffordable.
The horror stories are frequent and real. One of the worst we’ve experienced is that of an older man who had bought a policy through an agent many years back. His cash accumulation dried up completely before he became aware of what was happening. To retain his life insurance, he was required to pay the cost of his policy, plus the mortality risk charge, plus his base premium—all out of pocket and with no warning. To make matters worse, he had a major health issue and simply could no longer qualify for new life insurance. At a time when life insurance was more important than ever, the man had no means of protecting his family from potential financial hardship after he dies outside of a “final expense” policy to cover burial costs.
The Wall Street Journal published an article a few years ago about the risks of Universal life insurance in an article titled, “Draining Away!” The authors explain some of the risks that most consumers overlook, and they also explain how the investment value of your policy is closely tied in with how the market is performing, in particular, the current interest rates.
If interest rates stay low, which they are expected to, most Universal Life insurance clients will find their policies underfunded in the years ahead. In other words, the investment value will deplete faster than the rising cost of the life insurance coverage.
In this scenario, the cash value dwindles away until it has been exhausted. When this occurs clients are forced to pay extra money into their policy to keep their coverage or reduce the amount coverage they have to keep their policy affordable. In fact, according to Kenneth Himmler, president of Integrated Asset Management, 70% of the policies he sees are not generating the amount of income needed to pay the cost of the insurance.
With term life insurance or Guaranteed Universal Life insurance, your premiums do not change. The cost of your life insurance will always remain the same throughout the life of your policy. This eliminates the risk of the of unforeseen rate increases down the road when you need coverage the most.
We’re not saying cash accumulation is always a disaster in the making. Whether or not cash value in life insurance is a good investment for you will depend on numerous factors, such as your age, your health, and your financial standing.
But, there is indeed a blanket statement to be made: for the general population of working class Americans, life insurance is not a sound investment. At JRC, we typically only advise the ultra-wealthy (as in $300k per year and up) to consider investing with life insurance, mainly as a tax shelter. Even then, many experts will still tell you to steer clear.
When shopping for any type of life insurance, the key is to work with an independent agent who can provide a high level of consultancy and shop multiple carriers. Most importantly, be extremely cautious when considering investment strategies with life insurance.
Buying life insurance to protect your loved ones and don’t know where to start? JRC is here to help. Contact us toll-free at 855-247-9555, or click the button below for a free online quote. In just a few seconds, you can compare rates from dozens of top-rated life insurance companies.