09/02/2014 11:41 am ET Updated Nov 02, 2014

What Mom Never Told You About Cash Value Life Insurance

You know or you most likely figure you know something about life insurance. Whether it's with an employer subsidized plan or your own personal plan that you set up yourself, you probably have at least a rudimentary understanding of life insurance, what life insurance is, what it provides for -- that sort of thing. In fact, you may even be up to speed on your life insurance cash value. But, set that aside for just a moment and let's go on a little exploratory trip. Let's take this whole issue of cash value and put it under the microscope. You may, in fact be shocked at what you see once you turn up the magnification.

First up, go ahead and admit it. Life insurance, no matter how you look at it, can look ridiculously complicated. (Apologies to the insurance professionals here in this space, pardon the introductory material. But I invite you to stay with it, you may walk away a bit more informed.) Guess what, it looks complicated because it is complicated. No we aren't talking rocket science here, but then again we aren't simply balancing a checking account either. So, with that in mind, why don't we get started?

Cash Value Life Insurance by the Numbers
A good working definition is most often the best way to begin, so here goes. Cash Value Life Insurance is a generic term that refers to what is called permanent life insurance. That means it covers you for your entire life. You may also see it referred to as Whole Life, (No, not Whole Foods). Alternatively, you may also find it labeled as variable life or universal life. All of these terms are used interchangeable to refer to the same type of insurance.

1:Your Cash Value Is NOT a Bank Account
Your Cash Value Life Insurance is not set up to be used as your own personal ATM. You cannot just pull out the money that you see as cash value and use it, at least without paying for it. Yes, it is true, you can borrow against this cash value. Yet, this borrowing must be paid back and must be paid back with interest.

Here's an analogy that will help bring this home for you. You know how you can take out a loan against your 401(k) plan at your job? Well, with most Cash Value Life Insurance Plans you can do the same thing. You can borrow against the stated cash value. As long as you make your payments and eventually pay off that loan everything will be all right.

Alternatively, suppose you choose to stop (gasp!) making payments and make some sort of ridiculous claim that you don't need to pay back your own money. In that case you could end up triggering the lapse of your policy which will land you the cross hairs of some alphabet agency. More on this in just a moment.

2:Too Many Loans Will Sink Your Ship
Remember, at the end of the day, your cash value life insurance is an asset. But life insurance is somewhat of a unique sort of asset and must be handled with precision. For example, suppose you borrow against the stated cash value of your policy. If you stop making payments for any reason at all, your insurance company will announcer that your cash value life insurance loan value is too large and your policy is in danger of lapsing.

If you want to think of this in terms of the stock market, it's something like a margin call for an options trader. Your cash value life insurance agent will politely ring you up and ask for a prompt and immediate payment to catch your policy back up. Should you fail to do so, you can watch the dominoes fall one by one.

First, you will get an official letter from your insurance provider. Next, you will get a friendly letter from your favorite uncle. Yes, your Uncle Sam, except this time, he will bring along his friends from the Internal Revenue Service (IRS). In very official language you will discover to your dismay that you are now the proud owner of a hefty tax bill. Ouch!

3:Account Value is NOT the same as Cash Value
Heads up, quite a lot of folks miss out on the nuances of this one. You see it's like this. If you take the time to look at your last statement , you will find three different values reported. One of these is your stated account value, another is the cash value and the third is the surrender value. Now pay attention here, this is where the details get a bit hairy.

You see, if you ever read the fine print on your cash value life insurance policy you will discover something called surrender charges built in. You can find out how much this number is by comparing your account value and cash value on your statements. In other words, the difference between the two numbers is the surrender charge. You can think of this as the penalty or fee you pay for canceling the policy.

Insider's Secret
Guess what? The amount mentioned above, the surrender charge is the preferred manner in which insurance companies bury the sales commission. So obviously, if your insurance carrier charges a lower sales commission, the surrender charge will be lower. At the same time, the lower surrender charge means the surrender cash value is higher. See how that works?

Are Your Eyeballs Bleeding Yet?
As stated above, insurance, especially life insurance is a rather complicated affair. Thus many people find themselves blindly following their insurance broker's advice. Yet, you owe it to yourself and to your wallet to at least understand the basics of your life insurance.

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