A friend of mine asked me to review some old, whole life insurance policies he had established a while back.

They are dividend paying policies, payable until age 100, with a reputable, fraternal insurance company.

Just like other whole life insurance policies, the cash value is guaranteed to grow at a minimum, predetermined rate, and the death benefit is guaranteed to be paid as long as the premiums are paid and the policy does not lapse. Both the cash value and death benefit will grow even more when dividends are received and used to purchase paid-up additions.

This is all good news. These particular policies have been in force long enough that the accumulated cash values will exceed the total premium paid into the policies in the next two years or so-one policy is 15 years old, and the other is 18.

So, what makes a policy like the two described above different than the high cash value whole life policies we specialize in designing at Tier One?

Life insurance has significant tax benefits under the current tax code, including:

• Death benefit passes income-tax free to beneficiaries
• Cash value enjoys uninterrupted, tax-deferred, compound growth
• Paid-up addition surrenders of cash value are tax-free until basis is reached
• Policy loans can be taken against the cash value, tax free

In order to realize these tax benefits, a policy must conform to the IRS rules. A policy that has too much cash value relative to the amount of death benefit will be deemed a modified endowment contract (MEC), and no longer considered life insurance for the purposes of tax treatment.

The insurance company uses a test to determine how much premium can be paid into a policy without turning it into a MEC. This results in a range of potential premiums that could be paid into a policy with a given level of death benefit from the minimum amount required to sustain that death benefit, all the way up to the MEC limit.

By paying as much premium as possible up to the MEC limit while keeping the death benefit as low as possible, the policyowner maximizes the amount of cash value up front that can go into the policy.

This is appealing to those wanting a safe place to store cash that will earn far more than traditional checking, savings, or money market accounts. Cash value inside of a whole life insurance policy is not subject to stock market volatility, and can always be leveraged via policy loans. Once a policy loan is taken, the cash value continues to grow while the money from the loan can be used for anything the policyowner wants. Money is doing multiple things at once, which is a powerful principle of sound financial strategy.

So, what would a policy designed for high cash value growth early on look like compared to an ordinary policy?

There are a number of ways to design a policy, and the ultimate decision will be based on your unique situation and financial objectives. There is no one-size-fits-all approach, so talk to an advisor who specializes in integrating this type of policy into your overall financial strategy before making a final decision.

To keep things simple for this article, we will focus on three specific elements to look for in a policy illustration that indicate the policy is designed for early, high cash value accumulation:

1. Term Rider (may or may not be required)
2. Paid-Up Additions Rider (PUAR)
3. 7-Pay Premium (to indicate the MEC limit for the policy)

The presence of the term rider for this type of policy is to increase the death benefit, and therefore the MEC limit, to a level that will enable the policyowner to contribute a higher lump sum premium up front.

This is useful for someone who wants to move a significant amount of money from another asset into a whole life policy but does not want or is unable to continue paying that much premium on an ongoing basis.

The PUAR is what supercharges the policy cash values early on. Premiums that are paid into this rider purchase paid-up additions (PUA). Think of PUA’s as small chunks of fully paid for death benefit and corresponding cash value. Almost every dollar put into a PUAR is immediately available as cash value.

The 7-Pay Premium is where you look to see the maximum amount of premium that could be paid into the policy without making it a MEC. This is the MEC limit. While your premiums might not be at the MEC limit, they should be close if your desire is to maximize cash value early on and minimize the death benefit.

You will see all these elements in the following example.

This 40 year old male wants to pay $12,000 per year into a high cash value policy and pay an additional $20,000 into the policy up front for a total of $32,000 of premium the first year.

The first figure shows an ordinary policy. Premiums are $12,000 per year, payable to age 100, and the corresponding death benefit is $775,193. The MEC limit, as indicated by the 7-Pay Premium, on this policy is $31,603.51.