Cash values serve a valuable purpose.  They are great to have in your future and a very nice savings option that grows tax-deferred, and in most situations allow for money to be accessed without incurring any taxes.  Your cash values can be used for a variety of purposes, from helping you out of a tight financial spot in an emergency, providing funds to take advantage of an opportunity, or supplementing your retirement income.


What I’ve found interesting over the years when someone needs cash?  No one ever asks what was the rate of return.  Rather how much can I get and how fast can I get it?

You can borrow cash values at a relatively low-interest rate.  The cash value is collateral against the death benefit i.e., $100,000 face amount – $10,000 loan plus interest  = $90,000 (approximately) should death occur the day after receiving your policy loan.

The loan is not dependent on credit checks or other restrictions like loans from most financial institutions.  Money is sent to you within a couple weeks upon request.

Keep in mind that borrowing funds from your policy reduces your cash value and the death benefit if not repaid as shown in the example
above.  The insurance company is not going to knock on your door asking for repayment.  You can repay the loan on your terms and at your convenience, which is highly recommended.  You should pay the interest each year the loan is outstanding (recommended), and pay the loan back as soon possible.  Should you not pay the interest and continue to borrow the interest.  It compounds against the outstanding loan
creating debt.  

Cash values are great when you need them, and just as important to understand the costs and risks associated when tapping policy cash values.  You can alter the performance of the policy going forward with significant changes to the premium and potentially cause the policy to lapse if the loan or ongoing loans are not properly managed.


Some policies like variable universal life and indexed universal life are
designed with an investment mindset to be overfunded and used as an
alternative source of supplementing retirement income utilizing the
favorable tax advantages inherent in permanent life insurance.

Retirement Income
Great Expectations Button

These policies create the expectation of great tax-deferred cash value performance and a big pot of gold at the end of the rainbow.  Hopefully they will perform, unfortunately, they have even more trap doors and moving parts for the unprepared because cash values are not intended to be paid back and extinguished with an income tax-free death benefit paid out to beneficiaries.      

These rosy illustrations present scenarios requiring decades of accumulating cash and how many of these proposals will realize all of the benefits the illustrations projected?  Most will be different for a number of reasons based on the type of policy, the level and pattern of premium payments, interest rates, what’s guaranteed and what’s not guaranteed, indexed pricing options, caps, participation rates (determined by the company for IUL), market performance

(volatility) and the pattern of your returns along with nonguaranteed mortality.  The results years into the future are an unknown depending on actual policy performance and all of these moving parts are beyond the control of just paying premiums.

Can you continue the same or aggressive accumulation strategy that got you to the distribution stage of the policy?  Probably not! Was there any way to know this when you took the policy out?  What assumptions will have to be changed and what impact will they have on your supplemental retirement income stream of money?  

Who will you be dealing with in the future?  It could be a voice response robot at the insurance company to manage the distribution income phase of the policy.  Will you be able to articulate years into the future all of the specific details presented on the original illustration?

This is a real problem even if addressed at inception when the life insurance illustration was reviewed, signed and the policy was purchased.   

The policy contract means everything, but it doesn’t tell you how the policy has performed or will perform without ongoing in-force illustrations, and these in-force illustrations are even more important and vital prior to accessing retirement income and every year thereafter.  A small misstep without some guidance can have devastating consequences on the policy going forward, premiums you may or may not have to pay, and in a worst case situation should the policy lapse causing a potential tax time bomb.  Expectations must be managed properly in the accumulation phase as well as in the distribution phase of the policy, and the only way this can be accomplished is through ongoing in-force illustrations.

businessman with huge tax bomb
Papers with title tax liability on a desk.

During one’s life a policy will basically lapse when the outstanding loan exceeds the remaining cash value or no cash value remains in the policy (essentially the debt sinks the policy), and produces a significant tax liability based on the gain in the policy (cash value increase over and above premiums paid into the policy).  Your cost basis equals the premiums paid into the policy.  

Let’s assume a policy lapses with a $2,000,000 face amount, $600,000 outstanding loan, $200,000 premiums paid equals your cost basis.  This policy produces a $400,000 taxable gain and ordinary income tax is due on $400,000.  Let’s assume the same policy but the insured

dies with the same $600,000 outstanding loan.  The debt is simply extinguished and repaid from the death benefit.  The beneficiary receives $1,400,000 income tax-free.  More insights at “Understanding Loans on Cash Values”.

These policies can provide good value and supplement retirement income for the well informed.  The key to success with these types of life insurance products is active ongoing management with in-force illustrations and thoroughly understanding the trap doors and moving parts when touching cash values.     

Please refer to your appropriate tax advisor or accountant to discuss your personal tax situation regarding life insurance policy loans or the surrender of a life insurance policy.

Marc Maretsky Personal Insurance Services based in Beverly Hills, serves all of California and the United States.  I help my clients acquire life, disability, long-term care, and critical illness insured solutions, as well as enroll them into Medicare when eligible.

“No matter how fast technology changes our world and everything around us.  I believe the personal touch and a human voice are more important than ever.”

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