5 Reasons to Keep Cash Value Life Insurance
Before canceling any life insurance policy, examine ALL its features first!
- Do you already have life insurance that builds up savings, or cash value?
- Are you thinking about surrendering your policy and getting term insurance instead?
- Before you do, here are some things you’ll want to consider.
Term Insurance Can Be the Best Choice. . . .
Financial advisors often sing the praises of term life insurance, and with good reason. For many people, it’s truly their best choice. Take, for example, a young family with small children and a limited budget. Term insurance often provides a cost effective way to supply them with the large amount of insurance money they need. Should one of the parents die early, it will be many years before the kids are grown and through college. The surviving parent needs a lot of dough to help with all that, and term insurance is almost always their best choice.
But Not for Everyone!
But one-size-fits-all rules are like those big, sloppy t-shirts: they fit a few people well, many people poorly, and some people not at all. Depending on your circumstances, term insurance may NOT be the best fit for you. In particular, if you already have a policy which builds cash value, you need to think long and hard before surrendering it.
Cash Value—What is it?
Life insurance either builds cash value or it doesn’t. Term life insurance does NOT. It has only one component—protection. You buy it for a given term, or period of time. If you die during that term, your beneficiaries get the pay out, or proceeds. If you don’t die, your reward is that you’re still alive, and that’s it. There’s no residual—no savings, no investment.
Life insurance that DOES build cash value comes in many variations, such as whole life, variable life and universal life. These type policies have two components: protection (the pay out your beneficiaries receive if you die) and savings. How quickly the savings portion builds up and what it’s invested in can vary widely, depending on the structure of your policy.
Why NOT buy cash value life insurance?
Building up savings sounds like a good idea. So why is it that financial advisors tend not to recommend these type policies? For one thing, they can be complex—hard to understand, and even harder to evaluate. You may not know what you’re actually getting, and worse, neither may the agent who’s selling the policy.
For another, the rate of return on your savings or investment can be quite low compared to what you could be getting elsewhere. If you can afford the higher premiums that usually accompany cash value policies, advisors often suggest you buy lower cost term insurance and invest the difference in the payments in higher performing investments.
Should you keep your existing cash value policy?
However, like those t-shirts, cash value life insurance can be appropriate for some people. And, if you already have such a policy, here are some questions for you to consider before giving it up:
- Where are you NOW in the schedule for how the cash value builds up? Most of these policies build very little savings at first, but you may already be past those low buildup years. What you’ve already given up is gone, regardless of whether you decide to keep this policy or buy another. So all that matters now is how your cash builds up from this point forward, and if it is building up, you may want to keep the policy.
- Have you developed health issues since you purchased your policy? If so, you may never want to surrender your policy, particularly if your premiums remain constant through the years. It can be quite difficult, not to mention expensive, to get any type of new policy once certain health problems are discovered.
- What is your age? Unfortunately, the older you get, the more likely you are to pass away during a given time period. So the older you are, the higher the premiums, and term insurance may no longer be the bargain for you that it is for younger people. Worse, the increase in term premiums tends to take much bigger jumps each time you renew your policy.
- What is your tolerance for risk? Risk and return are positively related. That means if you want a higher return on an investment, you’ll probably have to take on a higher risk to get it. The higher the risk, the greater the possibility you’ll lose money as well as gain money. So, if risk is difficult for you to stomach, the low but guaranteed return which some of these policies offer may be extra appealing to you. But remember, any guarantee is only as good as the company that stands behind it. Make sure you go with a large, financially sound company that consistently delivers on its promises.
- Are you in a higher tax bracket? The savings portion of a cash value policy is allowed to grow on a tax-free basis. This feature becomes more attractive to people who are in higher tax brackets. Take, for example, someone whose marginal tax rate is at 50% versus someone who pays at 15%. (Remember, you must consider the total taxes that apply—federal, state, local, etc.) If a cash value policy earns at 4%, the person who is taxed at 50% would have to earn 8% on a regular taxable investment to be left with 4% after paying taxes. The person who’s taxed at 15% has to earn only 4.7% to be left with the same 4% after taxes. That means the higher the tax rate that applies to your regular taxable investments, the higher the risk you must take in order to be left with what you could earn on a tax free basis.
If you decide to surrender your policy—
After you’ve considered all the angles and decide that, yes, you want to quit your existing cash value policy, don’t leave yourself unprotected. Get the replacement policy up and running before you cancel an existing policy. If you leave a gap in your coverage, something could go wrong—like the premiums may be much higher than anticipated due to a health issue uncovered in your physical exam, or you could get hit by a freight train, or whatever. You get the idea.
Also, you need to formally cancel your policy and not just quit paying the premiums. If any cash has already built up in the policy, you want it refunded to you. Otherwise, if you don’t follow the company’s rules for canceling, they are likely to use up your cash value paying your premiums on your behalf until it’s all gone before they actually cancel your policy.
You can find more information on life insurance as well as other personal finance topics in my book, Money For Life. It’s available on Amazon as either a paperback or an e-book download for Kindle. [Note: you do NOT need a Kindle to read it. Amazon has a free reader download that allows you to read Kindle books on your computer.]