This weeks edition of senseless arguments levied against whole life insurance and universal life insurance is one my very favorites.
Even though I’ve addressed this topic before, I couldn’t pass it up knowing I’d be writing a series on the most common “complaints” used to dissuade the buying public from these products.
I do have to admit right out of the gate, though, that this one has a shred of truth behind it.
You can’t take it with you
The old argument goes something like this:
“When you buy permanent life insurance, the cash that accumulates inside your policy is not paid to your beneficiaries when you die. Instead the life insurer keeps the cash and pays you the death benefit.”
Oh the horror…
I’m here to confirm this statement. It’s true. Functionally speaking, no life insurer pays the cash value out of a life insurance policy to a named beneficiary. The cash stays with the insurer; the beneficiary gets the death benefit.
But if this disheartening news makes you want to take up arms against the insurance industry, slow your role just a smidge because I have some additional information that could potentially change your views entirely on this.
It doesn’t Work Quite the way You are Thinking
This argument takes a technically true but functionally speaking obsolete piece of information a bit too far. Really far in fact.
Just because the life insurer is keeping your money doesn't mean they're robbing you or your beneficiaries of untold millions. An example will help explain.
Let’s go back to last week’s ledger we used to point out that positive returns really don’t take all that long to materialize. Here it is again.
For what it’s worth this is a whole life insurance ledger.
Notice that the initial death benefit in year one is $1,149,725 and the cash value is $40,424. Notice also that in year two the death benefit is $1,270,374 and the cash value $86,384. That means the death benefit increased in just one year by $120,649 and the cash value increased by $45,960.
I don’t know about you, but I’ll gladly give up ~$46,000 if I receive $121,000 in exchange.
Now let’s skip to year 15 where the death benefit is now $1,723,254 higher than it was at the start while the cash value is $1,065,332 higher than it was at the start. Allow me to put that in graphical form for you:
So wait a minute. Why is this happening?
Permanent Life Insurance Policies can have Increasing Death Benefits
I need to be clear in pointing out that not all permanent life insurance policies do have increasing death benefits, but most can be set up this way.
This applies to both whole life insurance and universal life insurance.
The so-called “taking of your cash value” keeps the death benefit completely tax free—assuming there isn’t an estate taxable circumstance, Goodman Triangle issue, or employee benefit rule violation that creates a taxable death benefit.
The life insurance industry is not trying to extract every last dollar out of you and keep it as their own. In fact, from this example, the annualized rate of return in year fifteen given the planned premium and the death benefit is 15.54%. I personally find that offering quite generous especially given the risk involved (or lack thereof).
Yes, life insurers keep your cash and pay your beneficiary the death benefit. But so what? You end up with way more benefit as a result.