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High Cash Value Life Insurance

By Roccy M. DeFrancesco, JD, CWPP™, CAPP™ - Email Editor

Date : 19-June-2007

One of my favorite topics to talk about is “cash-value” life insurance. Many clients have it and have no idea how it works or if they have the “best” one to build their wealth. Because you can lose a significant amount of money or not grow wealth as well as you had hoped to by using a cash-value life insurance policy, the subject falls into my category as a “global” Asset Protection topic (meaning anyone or thing that can take your wealth is a creditor).

Generally speaking, I have disdain for the life insurance industry. Having said that, I am also life insurance licensed in some 20+ states and have made a decent amount of money selling life insurance to clients when appropriate.

When I get the chance to shed light on the confusing life insurance industry, I am only too happy to oblige.

If you have a cash-value life insurance policy, do you have one that has/had “high cash-value” in the early years of the policy?

If you have had a life insurance agent pitch you as to why you should use a cash-value life insurance policy to build your wealth, did they tell you there was such a thing as a high cash-value policy?

You might say to yourself “who cares,” or “why does that matter,” or “what are you talking about?” Because this newsletter is going out to non-advisors, I certainly could hear you saying that to yourself.

Let’s not put the cart before the horse

First, why do many people buy cash-value life insurance policies?

In two words: Wealth Building.

Cash-value life insurance is a unique animal because cash inside a life insurance policy can grow tax-free and be removed tax free in retirement. Therefore, many clients will position some of their liquid wealth in a cash-value life insurance policy to create their most tax-favorable retirement vehicle.

The problem

The problem with many cash-value life insurance policies is that they do not allow the cash in the policy to grow at market rates, and the expenses can be high.

One other problem is the liquidity of the policies. Many people have read the book Missed Fortune 101 by Doug Andrews. The book talks about how to borrow money from your home and reposition that money into cash-value life insurance. The concept is sound, although, in my opinion, the book has many technical flaws to it, (and why I’m coming out with my own book on the subject in the next few months).

One of the flaws of Missed Fortune 101 is it states that an indexed universal life insurance policy (which pegs the growth of the cash value to the S-P 500 index) is a good tool because it is liquid; and if a client needs money in a short-term cash crunch, it is available in the life policy.

That statement is simply false when it comes to 98% of the life insurance policies in the industry. Most life insurance policies carry large “surrender charges” so that if a client wanted cash from their policy or wanted to surrender the policy and receive the cash available, there would be very little available in the first 7-10 years of the policy.

Why do insurance companies have surrender charges that depress the cash surrender value of the policy? Two main reasons:

1) The insurance company had to pay a commission to a life insurance agent. These commissions are paid 90% up front in the year of sale.

2) The insurance company has several other initial expenses when issuing the policy like the DAC tax.

If a client surrenders the policy, the company builds in a large surrender charge to recoup the commissions paid, DAC tax and other expenses.

Surrender charges are not a big deal if you don’t need cash from your policy in the early years. Usually after 10 years, the surrender charges are gone; and you have full access to your cash-account value in the policy.

The problem is that real life sometimes happens to clients who may need access to the cash they positioned for growth in a life insurance policy. If you fund a traditional low cash-value life insurance policy (which includes 95% of whole life, universal life and indexed universal life) and you need the money paid in premiums back anytime in the early years, good luck. You will have wished you never purchased the policy in the first place.

A new kind of life insurance policy

Would you be interested to know that there are new life policies (one in particular) that has a high cash-surrender value in the early years of the policy? Your answer should be “sure.” It is interesting due to the fact that such a policy protects the consumer if cash is needed from the policy in the first 1-5-7-10 years.

If I’ve already stated that the industry norm basically requires a high surrender charge in the early years of the policy to cover costs, how can a company all of a sudden come out with a high cash-value policy?

The answer is that it can be done if the insurance company reduces the risk of loss due to its initial expenses. How can this be done? It’s actually very simple. If the insurance company spreads the commission of the life insurance agent out over a five-year period, it significantly reduces their risk. How? Because, if the policy is surrendered within the first few years, the insurance agent does not receive the remainder of his/her commission.

It’s easy to see how and why this works, but I can tell you from an insider’s perspective that insurance agents like to receive their commission (90%) up front in year one and do not want to wait five years to get paid in full.

Greed is a huge motivating factor in the sale of life insurance policies. I don’t have enough time in the day to tell you stories about insurance agents selling life policies that are NOT the best for their clients just so the agent can make a larger commission with another company or because the agent can qualify for a free trip to Europe if he/she places more business with one company over another.

Example:

Let’s look at an example of a high cash-value policy vs. a non-high cash-value policy. Assume you paid a life insurance premium of $10,000 a year, that you are male, age 45 and in good health.

How much cash surrender value would you have in the policy in the first three years in a non-high cash-value policy?

Year 1 $0
Year 2 $2,751
Year 3 $12,269

How much cash surrender value would you have in the policy in the first three years with a high cash-value policy?

Year 1 $7,019
Year 2 $14,612
Year 3 $22,768

If something goes wrong in your life, which one of these policies would you want?

Side note: While I very much like the high cash-value policies if you do not need to surrender the policy, the cash in your policy in the later years will be about 2.5% less due to the rider needed to kick in the high cash-value feature of the policy. This is a cost you must weigh when deciding which type of policy to purchase.

Conclusion

I am proud to say that I helped one of the insurance companies I work with to design what we call Revolutionary Life. This policy is a high cash-value indexed universal policy and is one I think consumers should be aware of. If you are in the market to build wealth through a tax favorable cash-value life insurance policy (like through the use of Equity Harvesting or the 1% CFA mortgage using your home as a wealth-building tool), then you should consider the new high cash-value policies in the marketplace.

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ABOUT THIS EDITOR:

Roccy DeFrancesco, JD, CWPP, CAPP, MMB - Author and lecturer, Roccy specializes in advanced estate and asset protection planning. Roccy's passion is to teach advisors how to implement lawful strategies that will hold up for the test of time.

Full Bio - Email Roccy