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 wit