The Five Funny Rules of Cash Value Life Insurance

There are several types of life insurance. They can all be classified as either term life insurance or cash value life insurance:

• Term life: Term life insurance provides coverage for a specific term. Most policies range from 5-30 years. If you die within the term of the policy, your beneficiary collects a death benefit.
  • Increasing Term: With increasing term, the policy premium (what you pay for coverage) increases each year, but the amount of coverage remains level. Annual renewable term is an increasing term policy in which the premiums increase each year.
  • Decreasing Term: With decreasing term, the premium remains the same, but the amount of coverage decreases.
  • Level Term: With level term, the premium and death benefit remains the same for the duration of the policy.
• Cash Value: Cash value life insurance is annual renewable term with a savings account attached.
  • Whole Life: Whole life insurance provides permanent coverage for the insured. A whole life policy also accumulates a cash value based on a fixed rate. The insured may cancel the policy and take out the cash value.
  • Variable Life: Variable life is a form of whole life in which the cash accumulation is based on investment performance.
  • Variable Universal Life: Variable universal life allows the insured to choose among investment vehicles for the savings portion of the account.

Whole life insurance costs more because it contains a savings component. The savings component, however, accumulates far less than it should. With a whole life policy, a certain portion of the premium pays for insurance and the rest goes into a separate cash account.

• Example: The premium is $200. The cost of insurance is $100. The amount that should go into the savings account is $100.

Although the premium for a whole life policy remains level for a long time, the cost of insurance increases, which means the amount going into the savings portion decreases.

• Example: The premium is $200. The cost of insurance is now $150. The amount that should go into the savings account is $50.

Eventually the cost of insurance exceeds the premium and money is removed from the cash account to cover the cost of the insurance. Once the cash account is depleted, the insured must pay an extremely high premium based on the insured's attained age.

• Example: The premium is $200. The cost of insurance is now $250. The amount taken from the account is $50.

Insurance agents push whole life because it produces a very high commission. And where does that commission come from? You guessed it, you. Cash value policies come with heavy fees that eat into the savings portion of your cash account.

Tell your insurance agent you want whole life insurance explained honestly before you purchase it.

Anyone trying to decide the term vs whole life insurance debate needs to look no further than the five funny banking rules of cash value life insurance:

1. There is no cash value for the first 3-5 years. Look at your policy. Find the page in your policy that shows guaranteed cash values. You'll notice it says $0 for the first 3-5 years. What happens to all that money? It goes to the person who sold you the policy in the form of policy fees. Because a variable universal life insurance (VUL) policy has no guarantees, there is no page with guaranteed amounts. The fees, however, still exist.
2. The money that makes it to your cash account earns very little interest, 2-4 per cent in most cases.
3. If you want your money, you have to borrow it. Although your money only earns 2-4 per cent, you have to borrow it at 6-8 percent.
4. If you want your cash value, the insurance company can hold it for 6 months. If you can plan your emergencies then don't worry about this provision.
5. If you die, your beneficiary gets the death benefit only and does not get the cash value. In other words, all that cash you accumulated goes to the insurance company at your death, not your loved ones.

"Don't buy term life insurance because I make a smaller commission" is not very convincing, so insurance companies have come up with better (lies) sales pitches:

1. Term insurance premiums increase each year: This is a lie. Level term insurance locks in your rate for a specific term, up to 30 years. Increasing term and annual renewable term does have increasing premiums. In reality, the cost of insurance with a whole life or variable universal life policy increases. If you don't believe me, look at your policy. There's a page which shows you the cost of insurance. Notice the cost goes up every year.
2. Whole life guarantees coverage for your entire life: This isn't an outright lie, but it is deceptive. What happens with most of these policies is the cost of insurance depletes the cash value. Once the cash value is less than your premium, you will pay a premium based on attained age. Many term policies offer the same provision at the end of the initial term.
3. If you don't die, you get to keep the money: Whole life agents also neglect to mention how much more cash you could accumulate if you bought term and invested the money you saved in an IRA or 401 (k). By doing so, you substantially decrease the need for life insurance. You'll have actual cash to pass on to your loved ones. It's called buy term and invest the difference.
4. VUL is the same as buy term and invest the difference: VUL is the same as buy term and invest the difference, with a whole lot of fees added on. VUL is how insurance companies pass the risk on to the consumer. If you're going to assume the risk of investing, you shouldn't have to pay the fees.
5. Whole Life is Guaranteed: Insurance sales people appeal to fear, especially when the markets are not performing well. If you're looking for a guaranteed investment, buy term and invest the difference in a CD or money market. You'll get a better return without the outrageous fees.
6. Look at all the tax advantages: Most Americans do not have a tax problem. They have an accumulation problem. Your investments will accumulate money faster outside of a cash value life insurance policy.
7. Look at all the tax advantages, part 2: Paying fewer taxes is an important strategy in wealth accumulation. That's why you should max out a Roth IRA and a 401 (k). These tax-sheltered investment vehicles allow you to accumulate wealth tax deferred, rendering the tax benefits of a cash value policy inconsequential.