Q. My life insurance has a cash value. What happens to it when I die? Does it go to my beneficiary in addition to the regular death benefit?
A. The cash value of a life insurance policy is part of the death benefit, not in addition to the death benefit. So, generally speaking, if you own a $200,000 life insurance policy that has $10,000 of cash value, if you died your beneficiary gets $200,000, not $210,000.
Q. That doesn’t seem fair. What happens to the cash value?
A. The cash value in a permanent life insurance policy is designed to keep the premium from increasing each year as you get older. By making the cash a part of the death benefit, the net amount of pure protection decreases as the cash value increases. In my example above, the net amount at risk is $190,000 ($200,000 – $10,000). Therefore, the amount of charge in this particular year for the net amount at risk is 190 X the rate per thousand at his age at that time. Since the cost of pure insurance increases per thousand each that we get older, it is important that the cash value increases to keep the level premium sufficient to maintain the policy in force.
Q. This is confusing and I have a friend who told me his policy’s death benefit was equal to the original amount plus the cash value. What goes?
A. You’re right. It can be confusing. Remember, I said that generally speaking the cash value is not added to the death benefit. Well, it is possible to structure your premium to create a policy whose cash value is added to the death benefit. At the time you purchase a policy you will probably have an option that would produce a death benefit equal to the original amount plus the cash value. However, maintaining this option for the life of the policy is very costly. Pure insurance costs increase exponentially with age, so if the net amount at risk does not decrease with age, the charge is very large.
Q. So what should I do?
A. That depends on your needs. I like an approach that keeps the death benefit level on a permanent policy to keep premiums low and if more pure protection is needed, cover it with term. But, the real answer is to find a good insurance agent who will work with to design exactly what you need.
COMING UP…MORE ANSWERS TO YOUR QUESTIONS (If you have some specific questions, let me hear from you.)