Your policy's cash value is not the same as its surrender value
However, in some cases, cash values that accumulates is large enough to use as additional leverage for more advanced purposes. Unfortunately, the general public is grossly under-informed as to the potential consequences of mishandling this money.
The Facts
Every monthly premium payment made by the owner of a permanent life insurance policy is divided by the carrier. Very simply, one portion is profit, one portion pays for the insurance coverage, and the remaining portion is deposited into the cash value account.
This last portion is essentially an over-payment. Since life-insurance companies will eventually pay out the death benefit in most permanent policies, the actual cost of the insurance gets more expensive as the insured person approaches the natural life expectancy age.
To keep the policy owner’s payments level, the insurance company charges a premium that is higher than necessary in the beginning, yet lower than necessary toward the end.
Function
During the earlier years of the policy, the portion of the payment that is excess is deposited into the cash value account, where it grows in a manner consistent with the specific type of permanent life insurance policy that was purchased.
Once the policy reaches the point when the owner’s payment is insufficient to cover the cost of the insurance, the flow of the cash value is reversed. Every premium payment made by the owner is then supplemented with the portion necessary to completely cover all costs of the insurance.
Time Frame
Most permanent life-insurance owners will not see any sizable sums in their cash value accounts for several years after their policy’s effective date.
Since the insurance company spends quite a bit of money during the application phase of the policy, the first several years are spent recuperating these expenses by withholding the owner’s overpayment.
Once the company has recovered the bulk of its initial outlay, that overpayment begins to accumulate in the cash value account.
Benefits
The purpose of the cash value is simply to maintain a level premium payment for the policy owner. Without the cash-value concept, the monthly payment would steadily increase until it was far too high for the majority of people to be able to pay.
Cash value can also act as a cushion in the event that a policy owner is unable to make a monthly payment. As long as there are sufficient funds in the account, the insurance company will automatically withdraw the necessary amount from the cash value to pay the cost of insurance if a scheduled payment is not received.
This process will continue until a large enough premium payment is deposited, or the account is depleted entirely.
Misconceptions
A common misconception, largely due to unscrupulous sales tactics and poorly constructed late-night television advertisements, is that cash value can be withdrawn at any time without consequence or penalty.
The fact of the matter is that any cash-value withdrawals need to be replaced by the policy owner if the premium payments are to stay level for the remainder of the insured person’s life.
If the withdrawal is not returned before the cash value is required to supplement premium payments, the policy owner will experience a steady increase in the monthly amount due that is equal to the increase in the cost of insurance.
Warning
Nearly every permanent life-insurance policy contract contains a provision called a “surrender period.” This is the length of time that must pass before the policy owner is entitled to the full cash value amount if he terminates the policy.
Due to the significant costs associated with instating a policy, the insurance company will simply keep all of the owner’s overpayments if the policy is willingly cancelled by the owner before the expiration of the surrender period.
Expert Insight
For consumers who are more properly informed, and whose individual situation presents the correct opportunity, there exists additional potential for leveraging the cash value. Because the cash value account often earns a rate of return, there is the potential for that account to accumulate more money than is necessary to pay for the increasing cost of insurance.
In this situation, the policy owner may take advantage of the excess funds by using them to supplement his normal monthly premium payment. The provisions of the policy contract may allow for an automatic withdrawal from the cash value.
In the case of significantly excess cash value, it may even be possible for the policy owner to cease making monthly premium payments entirely.
If sufficient excess cash value is available, a policy owner may also withdraw this excess money. The withdrawal is usually structured as a loan and no income taxes are paid on this money. If the policy owner does not repay the loan, most insurance contracts are structured to reduce the amount of the policy’s death benefit by the total outstanding loan balance.
Policy owners can take advantage of this feature by intentionally making premium payments well above the regular monthly payment amount. The excess amount is always deposited directly into the cash value account.
References
The Value of Cash Value
Tax Advantages of Cash Value Life Insurance
Resources (Further Reading)
Permanent Life Insurance
Cashing In Your Life Insurance Policy
This article is a Twisted Nonsense Exclusive! (07/22/2009)
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