Using whole life insurance as a place to store cash and to accumulate wealth works well for people who have a decent amount of discretionary income and realistic expectations. Most life insurance companies teach their agents that using a 10 pay whole life insurance policy is one of the best ways to accomplish the goal of accelerated cash value growth with a limited number of payments.
But it's not quite that simple. Making that assumption is a little bit of an oversimplification and causes a good bit of confusion with people looking to buy a whole life policy with the primary purpose of accelerated cash value accumulation.
The logic does seem to make sense on the surface. 10 pay whole life insurance does have better cash building potential than other flavors of whole life insurance…if you’re evaluating policies by the “off the shelf” features.
But you should be aware, that there are other whole life policies out there that offer much better performance if you are focused on the accumulation of cash. In fact, some of those other types of whole life policies can also function with a limited number of payments (similar to the 10 Pay) as well and give you superior cash value performance.
What is 10 Pay Whole Life Insurance?
10 Pay whole life insurance is a whole life product that becomes contractually paid up after ten years of payments. The policy only requires that the policyholder pay premiums for 10 years.
Once this 10 year payment period has passed, no future premiums are required, and the insurance company guarantees the death benefit will remain in effect until either the insured under the policy dies or the owner of the policy decides to terminate it.
Most of the 10 Pay whole life policies are participating whole life insurance policies, which means that they earn dividends (i.e., participate in the profits generated by the insurance company). Dividends paid to 10 pay whole life insurance policies come in the same fashion any whole life dividend comes. The policyholder elects a dividend option and realizes the benefits of dividends per that option when the insurance company pays dividends on the policy.
Cash Value Growth and The Basic Understanding
Most insurance agents understand that shorter guaranteed payment periods on whole life insurance products generally means greater cash value accumulation.
A lot of life insurers have (or have had) marketing and sales material that depicts the straightforward relationship between shorter guaranteed payment periods and the higher potential for cash value build up in the whole life insurance policy.
It seems perfectly logical then, that if you want the most cash value possible, the best bet is the products with the shortest guaranteed payment period, and few whole life products exist with shorter guaranteed payment periods than 10 Pay.
Whole Life Insurance Can Do Better
Despite the higher “basic” cash value growth found among whole life products with shorter guaranteed payment periods, there are options with whole life insurance policy design that will build far superior cash value than merely opting for the product with a shorter payment period.
Through the use of whole life insurance policy blending and large paid-up additions, we can build a policy that far exceeds the cash building potential found on a 10 pay product and often far exceeds the death benefit created by 10 pay whole life insurance. All of this for the exact same amount of premium.
What's more, because the blended whole life product has a highly flexible premium amount, this sort of policy poses a significantly smaller cash flow risk to the policyholder than a traditional 10 Pay policy would since he/she need not commit to a substantial premium payment of all 10 years.
The Basic Cash Building is not Magic
The fact that shorter payment period whole life products produce higher cash value is not magic. They require substantially higher premiums than whole life products with more extended payment periods. This means the life insurance company is merely collecting more money for the same amount of initial death benefit.
Your probability of death does not change because you bought a 10 pay whole life insurance policy instead of a policy that’s paid-up when you reach age 100. Accordingly, the life insurance company's risk of insuring you remains the same for both situations.
But the insurance company will ask you to fork over way more cash from the beginning because it needs to collect the funds necessary to “capitalize” the reserve it needs for the policy. Instead of building a pool of money to cover the risk associated with insuring your life over the course of your lifetime, the insurer only gets 10 years. It should come as no surprise that it's going to ask for a lot more money to do this.
As a result of this substantially higher ask from the insurance company, and the benefit-sharing nature of whole life insurance, the cash value created within 10 pay whole life products is a function of the excess cash you handed over to the insurer that it does not need during the early years of your policy.
You can accomplish much of the same thing merely buying a whole life policy paid-up at age 100 and using a paid-up additions rider to match the 10 pay premium.
The cash value will often look better. The death benefit amount will not be guaranteed in the same sense as 10 pay whole life insurance, but if you look at triggering the reduce paid-up option after the 10th policy year, the remaining death benefit amount will be similar to the 10 pay product.
What is the Better Option?
Keep in mind that when we seek optimized cash value, we simply try to minimize the base whole life premium per relative to the Modified Endowment Contract limit and fill this in with paid-up additions instead.
The MEC limit itself is a function of the outstanding death benefit so the longer the guaranteed payment period, the lower the required whole life premium. This also means the higher the capacity to load the policy with paid-up additions.
Can You Blend a 10 Pay?
Since 10 pay, by default produces a higher cash value, why not wed the cash building potential of 10 pay with the superiority of blended whole life insurance? On its face, it seems like a match made in heaven.
In some very specific circumstances, it's the best way to go.
But most of the time, considering the whole life issuing life insurance policies to choose from, using a true-blue, 10 pay policy is an inferior approach to constructing cash-rich whole life insurance.
The reason comes back to this basic principle:
More Paid Up Additions = Good for Cash Value Growth
More Base Premium = Bad for Cash Value Growth
Because 10 pay will always have a higher required base whole life premium, it will diminish cash building potential due to the higher expenses of base whole life premium.
There are other potential problems…
Several 10 pay whole life products either do not allow payments beyond the 10th policy year (including paid-up additions) or if they do, the products place severe restrictions on payments taking place after the 10th policy year (e.g., paid-up additions might be limited).
Also worth mentioning is that if you plan to buy the waiver of premium rider, the waiver will likely only last for the first 10 policy years and then terminate with the required base whole life premium.
What If You Want Maximum Cash Value With Limited Payments?
Everything up to this point sounds reasonable, but you are special. You want to maximize the cash value in a whole life policy, and you want to guarantee that you will not have to pay any more premiums after the 10th policy year.
Surely your super special circumstances of not wanting to make a long-term commitment of payments warrant an extra special look at 10 pay whole life insurance. Nope.
You can easily design a policy that optimizes cash value far better than 10 pay (blended or unblended) and still guarantees the policy will remain in force with no additional premiums after the 10th policy year. You can even put a policy in place that requires fewer premiums paying years than ten.
And you still have a policy with a higher discretionary premium and higher cash building potential than anything that’s a bona fide 10 pay.
It’s Not All Bad
After reading this, you shouldn’t come to the conclusion that 10 pay whole life insurance is awful. There is nothing wrong with the product so long as it's implemented for its proper purposes. Those seeking to guarantee a death benefit with only 10 years of premium payments.
While Guaranteed Universal Life Insurance has taken a large portion of the 10 pay marketplace, there are still those who wish to guarantee a death benefit while maintaining access to cash values and whole life insurance has always been a great option to meet that objective.
The purpose of this article and the podcast as well as to point out that 10 pay is not the vehicle for those seeking a whole life policy with the primary concern of building as much cash value as possible in the policy. A 10 pay whole life insurance policy is rarely the best option for that purpose.
What if You Bought 10 Pay Thinking it Was Best?
If you purchased a 10 pay whole life policy thinking it was your best bet for cash value building, you may or may not have made a mistake. Older 10 pay products were, in fact, excellent options for this purpose based on what products were available at the time.
Even if other products that could have performed better, it might be unwise to change course at this point based on the momentum you built with your whole life policy over the course of the last several years. That’s something that has to be looked at on a case-by-case basis.
If however, you still think you might have ended up with the wrong thing by buying a 10 pay policy seeking cash optimization, you could always seek out another opinion about your policy and its design. We can help, just head on over to our contact form and send us a message.
Brandon launched the Insurance Pro Blog in July of 2011 as a project to de-mystify the life insurance industry. Brandon was born in Northern New England, and he currently calls VT home. He attended Syracuse University and graduated with a triple major in Economics, Public Administration, and Political Science.
IPB 136: Leaving One Life Insurance Company for Another
Why don’t more Financial Advisors Sell Life Insurance?
Questions About Dividends, Direct Recognition, and IRA Liquidation to Fund Whole Life Insurance
Whole Life Insurance Rates: What’s the Cost of Waiting to Buy?