Dave Ramsey says that “the life insurance companies keep your cash value and only give the death benefit to your heirs.” This is a common thing we hear in the Infinite Banking Concept world.
Do those “money hungry” life insurance companies actually withhold your cash value from your heirs?
Let’s get to the bottom of this!
What is the cash value component of whole life insurance?
The “cash value” or the “cash surrender value,” is the present discounted value of the future death benefit minus the future premium payments (this definition is from Robert Murphy). You have these rights to exercise with your cash surrender value:
- Borrow Against (policy loan)
- Withdraw (this would only be a partial withdrawal)
- Surrender the policy for the “cash surrender value” (terminate the policy)
Cash value is a “living benefit” that whole life policies provide.
For example, let’s say that you have paid $50,000 worth of premium over a 10-year period. Your cash value is now $52,000 and the death benefit is $452,000. You can take a policy loan from the insurance company for $52,000, or you can surrender the policy and the insurance company will send you a check for $52,000 (the gain of $2,000 is taxable).
The policy is canceled and no longer in force if you choose the last of these 2 scenarios. If you choose the first option, policy loans, your cash value will be collateralized by the size of the loan taken. If you have any unpaid policy loans at death, they will be subtracted from the death benefit that is paid to the beneficiaries’ income tax free.
A comparison to home equity.
The cash value could be compared to the equity in your home. The more payments you make on your mortgage, the more equity you have in your home. That is the same with life insurance, the more premium payments you make, the more cash value you have.
One key difference with life insurance equity and real estate equity is that the cash value of a life insurance policy only goes up in value every year, while real estate is market dependent. The cash value is also much more liquid than home equity.
Why does whole life insurance have cash value?
When you start a whole life insurance contract, you and the insurance company are each agreeing to certain obligations to keep the contract in force. You, the insured, are agreeing to pay a premium monthly, quarterly, semiannually, or annually to the insurance company. In return, the insurance company is guaranteeing to pay a death benefit to your beneficiaries as long as these premiums are paid.
This guarantee is why whole life insurance has cash value.
The life insurance company knows they have to charge you a certain premium to guarantee the death benefit will be paid (it’s WHOLE LIFE insurance, and they know with certainty you will die). They also need to put this premium to work, to earn a return, to deliver on their promise. They choose to put money to work in low risk places, and you are the very best place for that, if YOU CHOOSE to exercise that policy right (a policy loan).
As each year passes, your chance of dying increases, which means the insurance company is getting closer to paying your death benefit. So, as the death claim gets closer, the present time value of your cash surrender value increases. This is due to the fact that your cash surrender value and death benefit will meet at age 121, when the contract endows.
So, does the life insurance company keep your cash value?
When you pass, the life insurance company only pays the death benefit to your beneficiaries. It does not add the present cash value to the death benefit in the payout. If you really understand what the cash value is, then it is clear why it is not added to the death benefit.
As stated above, the cash value represents the present discounted value of the future death benefit minus the future premium payments, and represents the “equity” that you have in the contract.
A short example to close.
Let’s compare the cash value and death benefit of a life insurance policy with a real estate example. The reason for this is many people are more familiar with real estate. Let’s jump right in.
Say you purchase a house and put some percentage of money down and get a mortgage to finance the remainder. This is similar to purchasing a life insurance policy and paying premiums, except for the fact of not needing to make a big down payment.
You work to pay off your mortgage in 10, 15, or 30 years, and now own your house free and clear. You could compare this to a 35-year-old purchasing a whole life insurance policy with premiums due until age 65. After age 65, no more premiums are due, but the now 66-year-old still owns the life insurance policy and the death benefit that comes with it. (I also want to note that future premium payments are not debt like a mortgage on a house is in this scenario. The two are only similar in the fact that payments are made to a financial institution and build equity in the asset)
During the years of paying the mortgage down you were building more equity in your house just as you were building equity in your whole life insurance policy as you paid premium (the equity with whole life insurance is called cash surrender value).
Later you go to sell your house. Selling will be similar to you passing away with the life insurance policy.
You can’t sell the house AND go back to the bank and ask them for all the money you paid them over the years on the house’s mortgage, plus get your down payment back. You just get the sales price of your house. So, if your house appreciated in value, maybe you have a total of $200,000 paid on it but sold it for $500,000 after 30-40 years. It makes total sense that you only get the sales price, not what you paid on top of the sales price.
Life insurance is no different.
The death benefit is like the sales price with real estate. The beneficiary receives the death benefit when the contract is completed by the insured’s death. They don’t receive the cash surrender value though on top of it. (I do want to add that the cash surrender value will be larger than the amount of premium you paid, typically in 2-14 years, just depending on the type of policy. This example did not take that into account.)
Hopefully this clarifies any confusion you have surrounding the death benefit and cash value with whole life insurance.
If you have any questions you can leave us a message on our website and we’ll get back to you by the next business day.