Cash Value vs. Higher Death Benefits: Which is More Important for My Estate Plan?


I recently met with a new client: a 68-year-old retiree who was re-evaluating her life insurance policy. She had a lot of questions about the nearly $500,000 in cash that had accumulated inside the policy since she first bought it back in the late 90s. She’d originally purchased the policy for income replacement to protect the futures of her three young kids. Now, 30 years later, her objective for the life insurance had shifted from income replacement to wealth transfer. And with an estate value exceeding $10 million and growing, she was now more concerned with using her policy to pass wealth along to her kids and grandkids without piling on an estate tax burden. That begged some important questions: Why is all this cash value just sitting here? And shouldn’t I be using that cash to maximize the death benefit instead?

What Causes Cash Value to Build?

When you make a life insurance payment, that premium is divided up in a couple places: one portion covers the cost of insurance (keeping the death benefit in place), while another portion covers the operating costs of the insurance company. What’s left over after paying these costs is the cash value.

How and when that cash buildup occurs will depend on a few things:

  • The type of policy you buy (such as whole life, variable life, or universal life)
  • The size of your premium payments
  • The interest rate environment
  • How the insurer’s costs change over time.

Thanks to a combination of paying premiums for many years and higher-than-expected interest rate crediting, many people have seen a significant cash buildup inside their life insurance policies.

The Advantages of Cash Value

Cash value is an opportunity of sorts. It’s a way for you to access some of the money inside your policy while you’re still alive. You can use that cash to pay premiums on the policy, cover other obligations, or simply as supplemental income. You’ll typically access cash buildup through policy loans, which tend to have low interest rates and don’t need to be paid back—instead, whatever loan amount is still outstanding when you die is simply subtracted from the death benefit.

 Is There a Better Use for Cash Value?

While having access to this seemingly “extra” money might sound nice, it might also have a better use. The main problem with a policy that generates substantial cash value is that your premium dollars may ultimately be purchasing a smaller death benefit as a result. If you were to exchange that policy for a new one, all of that accumulated cash is likely to buy you a higher death benefit, which eventually leads to a greater tax-free payout for your heirs.

This isn’t so much a downside as it is an opportunity cost. Think of it like a rental car that you’re allowed to return with an empty tank of gas. But suppose you fill the tank late in the trip or drive less than expected and ultimately return the car with a full tank? That $50 you spent on gas could have been used to pay for other things—maybe even to upgrade your rental. However, you did get some value from filling up the tank because you didn’t have to worry about running out of gas.

What Should I Do with My Current Cash Balance?

There are a few ways to get the most value out of the accumulated cash in your policy:

  • Use the cash value to pay your future premiums: Let’s say you have a $3 million policy on which you’re paying $50,000 in annual premiums to keep the policy in place. If your policy accumulates $300,000 of cash value over the past 20 years, you can use that cash value to pay your policy premiums for the next few years.
  • Use your cash value to increase your death benefit: Like we mentioned above, if you can comfortably afford your premium payments and have this excess cash building, you may want to leverage that cash into a policy with a higher death benefit. An advisor can analyze your current policy to see if a strategy like this makes sense for you.
  • Borrow it: You can usually take cash value out of the policy when it’s structured as a loan. Because you’re essentially borrowing your own money, the interest rates are typically very competitive. Also, if you die before repaying the loan, the amount is just deducted from the death benefit payment. This means you can take idle money and use it for anything, from paying your child’s tuition bill to purchasing real estate.

What Should You Do?

When it comes to estate planning, your strategy will always depend on your goals. If the purpose of your life insurance contract is to transfer wealth from one generation to the next, you should be more concerned with maximizing the death benefit over building the cash value. When pricing out life insurance, you’ll want to look for a policy that provides the highest death benefit given the annual premium payment you can afford to make. If the policy performs well and you start to accumulate cash, that’s great, but you’ll probably want to develop a strategy for this cash that will benefit your heirs.   

At Howard Kaye, we can help you find the optimal life insurance policy to meet your needs. We’re ready to help you improve your estate plan in ways you never even knew were possible. Contact us today and see how we can help you.


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