Introduction
Over the years it has become increasingly popular for the insurance industry to target dental and medical professionals with products called cash value life insurance. We’re not saying this is a bad product. It simply needs to be understood completely, and compared fairly to the other investments available to you.
As fiduciaries, it is our obligation to sit on the same side of the table as our clients, just as we would want from our own advisor if we were sitting in your shoes. We do sell these products, but only to a select group of individuals, typically clients who have a large retirement income gap and who have already maxed out every other tax-advantaged vehicle available to them.
The purpose of this newsletter is to give you a complete understanding of how these products work, the environments where they may be suitable for you, and how to compare them objectively to other investments you may already own or be considering.
The Three Main Types of Cash Value Policies
Cash value life insurance comes in several flavors, but most fall into one of three categories. The primary difference between them is how the cash value inside the policy grows, and how much of that growth is protected, if any.
Fixed (Whole Life and Fixed Universal Life)
In a fixed policy, the insurance company declares the interest rate that is credited to your cash value. Whole life policies offer a guaranteed minimum rate plus the possibility of non-guaranteed dividends when the carrier performs well. Fixed universal life credits a set interest rate declared by the insurer, which can move over time but will not drop below a contractual floor. In both cases, the growth is steady and predictable, but typically modest. You are not exposed to market losses, and you are not exposed to large market gains either. These policies prioritize stability over upside.
Variable (Variable Universal Life)
In a variable policy, your cash value is actually invested in subaccounts that operate much like mutual funds. You choose the allocation, whether stocks, bonds, or a blend, and your cash value rises and falls with those markets. There is no floor. If the market has a bad year, your cash value can decline, and underperformance can even put the policy at risk of lapsing if it is not funded properly. The upside is that you have the highest growth potential of the three types and the most control over the investments. The trade-off is real market risk on top of the cost of the insurance itself.
Indexed (Indexed Universal Life, or IUL)
An indexed policy is a middle ground. Your cash value is not actually invested in the market. Instead, the insurer credits interest based on the performance of an index, such as the S&P 500. The policy will have a floor, usually 0%, meaning your cash value will not lose money when the index has a down year. The policy also has a cap, which limits how much interest is credited when the index has a strong year. There may also be a participation rate that only credits you with a portion of the index’s gain. You are trading unlimited upside for downside protection. It is important to understand that policy fees and the cost of insurance are still deducted regardless of index performance, so cash value can still decline even when the floor holds.
Who Can Sell You These Policies
Not everyone who offers you a cash value policy is operating under the same standard of care, and this is one of the most misunderstood issues in our industry.
The first thing to understand is that “financial advisor” is just a title. It is not, by itself, a fiduciary status. Some advisors are legally required to act in your best interest. Others are not. The label on the business card does not tell you which is which. Broadly, there are two standards of care that apply to someone recommending a life insurance policy.
Fiduciary Standard
Registered Investment Advisors (RIAs) and their representatives are generally held to a fiduciary standard when they provide financial advice for a fee. Under this standard, they are required to put your interests ahead of their own, disclose and manage conflicts of interest, including the commissions paid on life insurance, and base the recommendation on a thorough analysis of your goals, your finances, and the reasonable alternatives. CFP® professionals are also required by the CFP Board to act as fiduciaries whenever they are providing financial advice, which the Board specifically defines to include recommendations about insurance products.
Suitability or “Best Interest” Standard
Most insurance agents and many broker-dealer representatives are held only to a suitability or “best interest” standard when they sell a product. Under this standard, the recommendation needs to be suitable for someone like you. It does not need to be the best option, or the most cost-effective option, or the one that beats every reasonable alternative. Compensation is typically commission-based, which creates conflicts of interest by design.
The tricky part, and this is the most important thing to understand, is that the same person can wear both hats in the same conversation. A fiduciary advisor may be acting as a fiduciary when discussing your investment portfolio, and then shift into an insurance-agent role the moment they recommend a life insurance policy, because the regulatory framework treats those activities differently. The standard of care can literally change in the middle of the meeting.
There is also a practical limitation worth knowing: non-registered insurance agents can only sell you insurance products. They are not licensed to sell securities or manage investment portfolios, which means you often will not hear about alternative options in the investment space, because the agent is not permitted, or trained, to discuss them.
Questions to Ask Before You Buy
If you are considering a cash value life insurance policy from anyone, including us, ask the following questions, and get the answers in writing if you can:
• Are you acting as a fiduciary to me for this recommendation?
• Will you put in writing that you have a fiduciary duty to act solely in my best interest regarding this policy?
• How are you compensated if I buy this policy? What commissions, bonuses, or incentives will you receive?
• What alternatives did you consider, and why is this specifically in my best interest versus those alternatives?
If the person selling you the policy dodges these questions or declines to put fiduciary status in writing, we would generally recommend treating them as not acting as a fiduciary in that transaction, regardless of what they informally tell you. A true fiduciary will welcome these questions and answer them directly.
The Pluses
When these policies are designed correctly and used in the right situation, they offer several meaningful benefits:
• Potentially tax-free income in retirement. When properly structured and kept in force as a non-Modified Endowment Contract, you can access the cash value through policy loans that are generally not treated as taxable income, which can be a valuable supplement to taxable retirement accounts. Tax treatment depends on ongoing policy performance and compliance with IRS rules.
• Life insurance coverage is included. Most of us need life insurance at some stage of life. These policies provide a permanent death benefit that does not expire at the end of a term.
• Asset protection features. In many states, the cash value of a life insurance policy receives some protection from creditors, but the extent and conditions vary meaningfully by state and by circumstance. We recommend consulting your attorney for guidance on your specific situation.
• Tax-deferred growth. Your cash value grows without annual taxation, much like a qualified retirement account.
• Access before age 59½. Unlike IRAs and 401(k)s, there is no 10% early-withdrawal penalty on policy loans, which gives you flexibility if you need the money earlier in life.
• No contribution limits. There is no IRS cap on how much you can contribute, though the amount of life insurance you qualify for will effectively set the ceiling, and that in turn shapes the optimal design of the policy and the premium flowing into it.
The Minuses
These products also carry real trade-offs that need to be understood before you commit:
• Heavy front-end costs. The cost of insurance and policy charges can significantly impact cash value in the early years of the plan. Some policy designs mitigate this, but usually at the cost of lower cash accumulation in later years or higher overall costs across the life of the plan.
• Built-in conflict of interest on compensation. Agents are paid through commissions, often very large up-front commissions. This creates a financial incentive to steer high-income earners toward these policies, and to favor the policy designs that pay the most rather than those that perform best for the client. Even a fiduciary advisor typically switches into an insurance-agent role when selling a policy, so you have to be very careful here.
• Surrender penalties. Most policies include surrender charges that prevent you from taking some or all of the cash out in the early years. In practice, you often need to hold these plans for 15 to 20 years before the cash value starts to look attractive enough for the policy to perform the way it was originally sold.
• Premium rigidity. Some policies require fixed premiums. Miss them and the policy can be surrendered entirely. Others offer flexible premiums, but there are real limits to that flexibility. You cannot simply stop funding the policy early and expect it to perform as illustrated.
• Complexity. These are some of the most complex financial products on the market. Illustrations rely on assumptions about future interest rates, dividend rates, index performance, caps, participation rates, and costs that can all change over time. What is illustrated on day one is not guaranteed.
Whether a cash value policy is appropriate for you depends on your specific tax situation, income level, existing retirement savings, asset protection needs, and long-term goals, and should be evaluated alongside your tax, legal, and financial advisors.
Understanding Internal Rate of Return (IRR)
Internal Rate of Return, or IRR, is the single most useful number for evaluating whether a cash value life insurance policy stacks up against your other options. Put simply, IRR is the annualized rate of return that makes the money you put in equal to the money you get out, accounting for the timing of every cash flow. It is the true year-over-year growth rate of the policy.
Every life insurance illustration can produce an IRR report, sometimes called an IRR ledger, showing the cash value IRR and the death benefit IRR at each year of the policy. When you are evaluating a proposal, we strongly encourage you to ask for the IRR report. If the agent cannot or will not provide it, that alone tells you something.
Why IRR matters for comparison: Because the income from a properly structured cash value policy can be tax-free, IRR allows a fair, apples-to-apples comparison to a taxable investment only if you convert to a tax-equivalent basis. The math is simple: divide the policy’s IRR by (1 minus your marginal tax rate).
For example, if a policy projects a 6% IRR and your marginal tax rate is 37%, an alternative taxable investment would need to earn roughly 9.5% per year just to match the policy on an after-tax basis (6% ÷ 0.63). Without this adjustment, the comparison is not honest in either direction.
A Final Thought on the Stock Market Comparison
If you are primarily a stock-market investor with a long time horizon and the discipline to stay invested, the historical returns of a diversified equity portfolio have typically outperformed the net-of-tax return on a cash value life insurance policy. This is not a simple comparison. Tax treatment, sequencing of returns, creditor protection, estate planning considerations, and your own behavior all matter, but it is the honest starting point.
This is exactly why we recommend that anyone considering one of these policies have it explained in full detail by the person selling it. We would encourage you to ask for the IRR report, to ask what happens if you stop funding in year five, year ten, or year fifteen, and to ask what the policy looks like if the crediting rate, cap, or dividend comes in lower than illustrated. Compare it honestly against the alternatives on a tax-equivalent basis.
If you would like us to review a policy you already own or one you are considering, we are happy to look at the illustration alongside your broader financial plan and give you an objective opinion.
Questions? If you have questions on your personal situation outside of your annual review, please reach out to your Advisor directly. For non-clients with questions, reach out to us and an Advisor will contact you to schedule a complimentary consultation.
Disclosure: This newsletter is for informational and educational purposes only and does not constitute investment, tax, or legal advice. Life insurance products involve risks, fees, charges, and surrender penalties that may not be suitable for every investor. Guarantees are subject to the claims-paying ability of the issuing insurance carrier. Projections and IRR figures shown in a policy illustration are hypothetical, are not guaranteed, and depend on assumptions that may change. Tax treatment depends on proper policy design and compliance with IRS rules, including Modified Endowment Contract (MEC) rules. Always consult your tax and legal advisors regarding your individual situation. Investment Advisory Services are offered through Virtus Financial Partners LLC, a registered investment adviser. Registration does not imply a certain level of skill or training. Insurance products and services are offered and sold through individually licensed and appointed agents in all appropriate jurisdictions.
