Whole Life Long Term Cash Value

When buying whole life insurance for its cash value, we generally have a very long term view on the strategy.  Even though someone might want access to the money in the life insurance policy within a few years, we still want to maximize the lifetime value of the dollars committed to whole life insurance. To accomplish this, we have to build a policy that focuses on optimizing the cash accumulation aspects of the policy and have to analyze projected policy performance well into the future. We have provided several resources on the first step of this process. But up until now, we've said very little about the second.  It has come up in passing several times, but today I want to focus specifically on it because it's a subtle, but extremely important element to building long-term maximized value in a whole life policy.

Analysis with Leverage in Mind

Extracting value from a whole life policy often involves leverage.  This comes in the form of taking a policy loan against the cash value in the policy.  This unique feature of life insurance unleashes a very powerful opportunity to build not only wealth but also income creation. The loan feature of a life insurance policy pledges cash value accumulated in your policy as collateral from a loan issued by the insurance company.  Given this, the more cash value you have, the more you can pledge for an ever-larger loan balance.

This aspect of life insurance allows it to be extremely competitive against other savings/investing methods to accumulate retirement income assets. But one of the tricky considerations of pledging assets for loans is the future value of said assets.  When someone, for example, takes an equity loan against their home, they do it with the hope that their home will increase in value over time.

The same is true when anyone pledges collateral for a loan (a common practice among businesses to raise the capital needed for other investment opportunities). One cool thing about whole life insurance is that we have a road map that shows us roughly what the asset will be worth well into the future and we can use that anticipated growth in the asset (i.e. the cash value) to extract greater amounts of value from the policy–especially when it comes to retirement income creation.

Example Three Policies Compared

Several years ago I ran some life insurance illustrations for someone who wanted to evaluate three whole life insurance options for a cash value-focused purchase.  He was 38 at the time and was hyper-focused on building as much cash value as quickly as possible.  However, we also had a lengthy conversation about the desire to use this policy for retirement income at some point.  In truth, the focus on early cash value always baffled me as he had no plans to touch the money in the near-term. Here is a comparison of year 1 cash values from the insurance ledgers: Guardian Whole Life Most Cash Value First Year MassMutual Whole Life First Year Cash Value     Penn Mutual Whole Life First Year Cash Value Looking at these three whole life ledgers, we can see that one is clearly ahead in the first year; this happens to be the Guardian policy.  It's easy to assume that this gives Guardian the advantage and that policy is most likely the best bet. I think a lot of people assume that the whole life policy with the most cash value from the outset will continuously compound this higher cash value amount and ultimately come out ahead of the others.  While this makes intuitive sense, it's rarely true. Looking at the ledgers at more advanced years (age 100 specifically in this case) we see that the order of who has the most cash value changes dramatically: Guardian Whole Life Age 100 Cash Value MassMutual Whole Life Age 100 Cash Value Penn Mutual Whole Life Most Cash Value Age 100 Now the Penn Mutual policy has a considerable lead, and the MassMutual policy also comes out significantly over the Guardian policy, which has nearly half the cash value that the other two whole life policies have. What gives? Whole life policies tend to become more efficient as time goes on.  Some whole life contracts are better at this than others.  But there is an even more important subtle point that I wished to serve as the focal point of today's discussion.

Long-Term Cash Value's Impact on Overall Value

We sometimes get lost in arbitrarily assigning significance to a specific point in time.  When evaluating life insurance policies for cash value accumulation, it's common to see people compare the projected values at year 10, 20, or perhaps age 65 (common because that's around the time a lot of people believe they will retire). While it's okay to compare cash values at this point, we ultimately want to buy whole life insurance for cash value because we want to extract value from it over a lifetime.

Looking simply at how much cash value is in the policy at some arbitrary stop along our journey (say year 20 for instance) only tells us a piece of the story.  We may be too myopic using this approach and overlooking lifetime value available to us. Keep in mind that extracting value from whole life insurance usually involves policy loans.  These loans simply balance the cash value of a life insurance policy against the balance of an ever-growing outstanding loan.

The plan is that the insured eventually dies and the death benefit retires the outstanding loan balance–paying whatever remains after loan payoff to beneficiaries. Doing this means we ultimately want to achieve the highest amount of value by the time death takes place.  We never truly know which option will yield the highest value, but we can make educated guesses about which option is the winner by comparing these ledgers.

Policies that report higher cash values in advanced years have a higher likelihood of providing the policy owner with more value over his/her lifetime.  This of course necessitates a review of the underlying assumptions about the way values accumulate in a life insurance policy.  But providing those checkout, this analysis remains solid.

Short-Term Focus with Realistic Plans

We talk to a lot of people who plan to use their whole life policies for some sort of investment acquisition in a self-banking-esque strategy.  For a lot of these people, short-term cash value accumulation is extremely important, but there are times they violate the rules outlined above because they have a hard time thinking more long-term. For example, the policy that has the most accumulated value by year 5 is the winner because that will give me the most amount of money to employ towards building my real-estate empire, which I'd like to do sooner rather than later.

The problem is that usually the difference between policy cash values from one whole life option to another within this timeframe is relatively small–maybe a few thousand dollars, as seen in the example above. These people quite literally approach whole life buying with a plan to forfeit potentially millions in lifetime value for a few thousand dollars in the short term.  That will require one heck of an investment strategy to overcome the difference.

What's more, I've never sold a whole life policy to someone who leveraged every dollar within five years and truly but it to work doing something useful for an investment strategy.  In other words, the likelihood of needing every dollar available by year five (or whatever year it is) is very low.

Whole Life Blending Still Important

I want to be clear about something in the context of this discussion.  Just because I'm saying that the most absolute cash value in the short term may not be the best bet does not mean I'm suggesting we ditch blending because a non-blended whole life policy will start to catch up to a blended one much longer term.

There is, no doubt, still plenty of value in having as much cash value as we can reasonably make available in the short term, but we have to balance that out with long term value.  Because what whole life insurance can unlock for someone can be life-changing, and we a plan that looks both short and long term to maximize what we can accomplish with whole life insurance.

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